Abstract:
A large informal sector is a challenge for developing countries building up social
protection systems. Expanding social safety nets reduces poverty, but financing them can increase
the tax burden, potentially reducing availability of formal sector jobs. This paper quantifies impacts
on income distribution and efficiency of expanding developing countries’ social protection. Results
from a new tax-benefit microsimulation model for Ghana are combined with the extensive margin
elasticity of the share of formal work with respect to the tax wedge on formal labour. Estimated
formality elasticity is modest but statistically significant; therefore the distributional gains of
expanding cash-transfer programmes are considerable, even taking into account behavioural
impacts.