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INFORMAL ECONOMY IN A DYNAMIC POLITICAL FRAMEWORK

  • Ceyhun Elgin (a1)
Abstract

I develop a dynamic political economy model with an informal sector and two political parties alternating in office. In equilibrium, if the incumbent political party faces a higher probability of staying in office, it sets a higher tax rate on the formal economy to invest more in productive public capital, while spending less for current office rent. Moreover, I argue that public capital is mainly utilized by the formal sector, and this implies that countries in which incumbent parties are more likely to stay in power have a higher tax burden but a smaller informal sector. I also present some empirical evidence that supports the main results of the model.

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Corresponding author
Address correspondence to: Ceyhun Elgin, Department of Economics, Bogazici University, Natuk Birkan Hall, Bebek 34342, Istanbul, Turkey; e-mail: ceyhun.elgin@boun.edu.tr.
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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
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