Labor market institutions, taxation and the underground economy

The paper aims at qualifying the links between labor-market-institutions, taxation, tax monitoring, and underground economic activity. The proposed model is a continuous time matching model with one commodity roduced either overground or underground. Underground economic activity arises because of partial compliance with regulations and tax contributions imposed by the government. Vacancies and workers search are directed at a specific labor market. Workers are heterogenous in the subjective cost they face when operating in the irregular sector. Analytical and numerical investigations suggest that interactions between regular and irregular activities can affect standard results of policy interventions. In that respect, the paper supports the view that policies aiming at increasing individuals benefits of participating in the regular sector are more desirable than a deterrence policy.