Firms Inormality: A Model and Empirical Evidence for Lebanon

This paper tests the implications of a simple equilibrium model that describes the informal economy in Lebanon. The results suggest that informal firms are less productive, managed by less educated entrepreneurs, are smaller and face less inspection from the tax department and the social security audits, which we verify in the data. The paper also investigates how the quality of legal enforcement, captured by the likelihood of detection in the informal sector, affects firms’ decisions to be formal or informal. Since enforcement may be endogenous, we instrument this variable with the distance between the city where the firm is located and the closest enforcement offices.