While examining the macroeconomic effects of government tax
and punishment policies, this paper develops a three-sector general
equilibrium model featuring matching frictions and worker-firm wage
bargaining. Workers are assumed to differ in ability, and the choice
of education is determined endogenously. Job opportunities in an informal
sector are available only to workers who choose not to acquire
higher education. We find that increased punishment of informal activities
increases the number of educated workers and reduces the number of unemployed workers. Considering welfare, we show it is
optimal to choose punishment rates so to more than fully counteract
the distortion created by the government’s inability to tax the
informal sector.
JEL-codes: H26, I21, J64
Keywords: Tax evasion, underground economy, education, matching,
unemployment.
