@misc{37094,
title = {Labor Income Tax Progressivity with a Large Informal Sector (Discussion Paper)},
author = {Ayres, João and Pedroni, Marcelo and Rossi, José Luiz},
year = {2025},
doi = {10.18235/0013717},
abstract = {We study labor income tax progressivity in an economy with a large informal sector. When the cost of informality rises with productivity, greater progressivity can simultaneously reduce inequality and enhance efficiency. We extend a standard heterogeneous-agent incomplete markets model to include workers choice between formal and informal employment, calibrating it to Brazilian data. The informal sector features a distinct productivity process and partial tax avoidance, consistent with empirical evidence. A policy experiment shows that increasing progressivity lowers inequality and raises GDP without reducing government
revenues. The results offer a novel rationale for progressive taxation in economies with widespread informality.},
url = {https://doi.org/10.18235/0013717}
}