Characteristics of households in the informal sector of an emerging economy

Abstract

Using the case study of Trinidad and Tobago, we investigate the socio-economic, demographic and attitudinal characteristics of households that participate in the informal sector of an emerging economy and their perception of the risk of detection by tax authorities while doing so. Data are gathered from a cross-sectional field survey covering 570 households. Results using multinomial logit and ordered probit models suggest that households are motivated to participate in the informal sector when members spend little time in formal sector activity, believe that taxes are too high and their incomes are too low, have dependents to support and believe that the resulting tax evasion will go undetected. Their perception of the risk of detection by the tax authority is determined largely by the income they earn in the formal sector and the extent of government bureaucracy prevailing there.

Notes

¹ See Gërxhani and Schram (2001), Gerxhani (2002, 2003) and Schneider (2005).

² The term ‘informal sector’ as used in this article encapsulates’economic activity that falls outside the purview of government accounting’(Fleming et al., 2000, p. 387). The concept of the informal sector or economy is well known though its definition is subject to some controversy (Schneider and Enste, 2000, 2003). Indeed, it is known by various other names like shadow, hidden, black, underground, gray, clandestine, illegal and parallel (Fleming et al ., 2000, p. 387). In defining it as we do, we divide the total economy into its informal and formal components. In this article we concentrate solely on households participating in the informal sector.

³ See Rampersad (1987), Lloyd-Evans and Potter (2002) and Maurin et al . (2006).

⁴ These correlations are illustrated by Neck et al . (1989). They emphasize the problems of making policy implications with these models, as one has to consider numerous restrictions when applying these models to reality. See Schäfer (1984), in particular the chapters by Carlberg (1984) and Wiegard (1984).

⁵ However, there are incentives for unemployed individuals to abuse the system, depending on the kind of transfer payments.

⁶ See Allingham and Sandmo (1972), Andreoni et al . (1998), Mettelsiefen (1984), Petersen (1984) and Sandmo (1981). In crime theory, Becker (1968) additionally considers the probability of being detected as well as the severity of the punishment.

⁷ See also Bös and Felderer (1989); Cowell (1989, 1990); Hackmann (1984).

⁸ The reference modality is the factor that is not used in the estimation of the model.

⁹ The purpose of this normalization is to identify the model's parameters. See Greene (2003) for a more detailed discussion of the estimation procedure.

¹⁰ Using the log-likelihood of the full model (ln L ₁) with the one from the constant only model (ln L ₀) the likelihood ratio test statistic is computed as follows:

¹¹ It is also interesting to note that Schneider et al . (2001) did not find any effect of government bureaucracy and red tape on the supply of goods and services to the informal sector.

¹² We owe this observation to an anonymous referee of Applied Economics.

¹³ It seems reasonable to suggest that a person's actual participation in the informal sector will not be a factor determining his/her perceived risk of participation, at least in static framework used in this article. The same caution about possible simultaneity bias in the case of the results shown in Table 2 also apply here, since some of the variables in this equation may be simultaneously determined. This should be borne in mind when interpreting the results shown in Table 3.

¹⁴ Several authors (see Long, 1997, Long and Freese, 2006) prefer the McKelvey-Zavoina to the McFadden R ² on the grounds that it more closely approximates the R ² obtained from regressions on the underlying latent variable.

¹⁵ Not long ago, there was a rowdy protest by commuters who objected to the raising of fares by the PH drivers. This was reported in the national media as it would have been done if the PH drivers were a legal entity.