Boeri and Garibaldi.

• Position: Conferences

In an equilibrium model of the labor market with market frictions, Boeri and Garibaldi investigate the border between formal employment, shadow employment, and unemployment. From the labor demand side, firms optimally create legal or shadow employment through a mechanism that is akin to tax evasion. From the labor supply side, heterogeneous workers sort across the two sectors, with high productivity workers entering the legal sector. This worker sorting is fully consistent with most empirical evidence on shadow employment. The model also sheds light on the "shadow puzzle": the increasing size of the shadow economy in OECD countries despite improvements in technologies for detecting tax and social security evasion. Shadow employment is correlated with unemployment, and is tolerated because the repression...