Thresholds, informality, and partitions of complianceInternational Tax and Public Finance

Abstract: This paper aims to establish and explore the links between two threads in the public finance literature. One is the use of tax thresholds to partition taxpayers into those who are liable to pay tax and those who are not. The other is the notion of ‘informality’ as a central challenge for tax design and implementation. Several insights emerge. First, the results make clear that the term ‘informal’ as used in the literature is imprecise and can consequently be very misleading: the models reveal a range of compliant and non-compliant behaviors with very different welfare and revenue implications. Second, the various forms of behavior considered suggest optimal thresholds generally higher than would otherwise be the case, with quite complicated implications for the associated patterns of (non)-compliance. Third, when (as is realistic) firms and individuals face multiple tax and non-tax obligations, the setting of optimal thresholds is considerably more complex.