An Empirical Model of Labor Supply in the Underground Economy
This paper uses micro data from a random survey carried out in the region
of Quebec City, Canada, to estimate a model of labor supply in the underground
economy. The model assumes that the individual's gross wage rate in the
regular sector is parametric while his gross labor earnings in the underground
sector are a concave function of hours of work. This distinction between the
two sectors is used to generate a simple separation result between preferences
and the magnitude of underground labor market activities. This result implies
that the individual's labor supply in the underground economy is generally a
negative function of his net wage rate in the regular sector. The separation
result also implies a set of restrictions on the parameters of the reduced form
of the model, which are imposed using minimum distance methods of estimation.
Various generalized method of moments specification tests allow us to verify
the validity of these restrictions.
According to our results, the marginal tax rates embodied in the Quebec
tax-transfer system are an important determinant of the decision to participate
in the underground sector.
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