The objective of this paper is to explore the factors that affect the size of the Palestinian informal sector, including the costs and benefits associated with informality or formality, and the quality of government institutions. This paper identifies informal businesses as those with no tax records and no formal registration. Informal business covers all economic activities except agriculture, since most agricultural activities are exempt from tax under Palestinian tax regulations. The empirical analysis of this paper uses secondary data from a number of sources, including a 2008 mixed household-firm survey; a 2013 survey of Palestinian informal entrepreneurs on the local investment environment of the informal sector; the World Bank’s ranking of countries on the Ease of Doing Business indicator; the World Bank’s World Wide Governance Indicator; and the World Bank’s enterprise survey. These sets of data are used for several purposes, including estimating the size and characteristics of the Palestinian informal sector, analyzing motives to join the informal sector, and analyzing linkages of informal sector activities to the quality of public institutions. The empirical findings of this paper lead to a number of policies for regulating the informal sector and enhancing tax compliance.
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