Moonlighting production, tax rates and capital subsidies

JEL codes: 
E22, E26, H25, H26
Version Date: 
Mar 2011

Informal firms play a crucial role in both developing and developed countries, and there is
evidence of a larger presence of moonlighting firms over ghost firms. The former are firms
that operate simultaneously in the official and unofficial sectors, whereas the ghost firms
undertake their production only underground. In order to deal with this evidence, through an
ad-hoc assumption we represent a specific technological advantage of moonlighting firms
over ghost firms, modelled through an aggregate-capital externality. In this setting we
examine the steady state effect of fiscal policies aimed to support firms, in particular
investment subsidies and tax allowances, on firm size and underground production. Among
the main results, a tax cut (rise), induces the moonlighting firm to engage in more (less)
official production. Contrary to the presumption that subsidies may also be useful for pushing
firms to operate over ground, in the presence of moonlighting technology, the incentives to
improve capital stock turn out to be counterproductive in that they increase the unofficial
economy overall.

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