In Albania, the informal sector, while sizable and crucial to the economy, has not been formally analyzed in depth. On the one hand, it contributes to providing many individuals with employment alternatives. On the other, it can increase vulnerability by keeping people out of the social security system. This study applies a micro-simulation model that allows counting for both formal and informal employment, to investigate the implications of a flat-tax regime on informal employment. It finds that the flat tax implemented since July 2007 has not contributed to the reduction of labor informality, but that increases in regular wages have played an important role in convincing individuals to move to the formal labor market. Furthermore, it finds that controls and audits are more efficient than fines in inducing people to switch from the informal to formal labor market. These results imply that a kind of progressiveness should be put back into tax policy, without affecting the attractiveness and simplicity that a flat tax entails.
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