We use a micro-macro simulation model to evaluate the efects of labor income tax policies in South Africa. The country is characterized by a high unemployment rate while employment in the informal sector is relatively low. Our approach is based on the aggregation of the preferences of individuals who choose among working in the formal sector, working in the informal sector, and not working. We quantify the efects of different tax policies on the individual’s labor supply choices (formal/informal employment, work/leisure) and at the macro level (GDP, equilibrium wages, size of the informal sector, and unemployment rate).

We further analyze the eects in terms of income distribution, poverty and inequality. We nd that the introduction of a negative income tax system reduces inequality and poverty but, at the same time, discourages people from participating in the labor market and working in the formal sector and, consequently worsens the equitye ciency trade-o. We nd however that the equity-eciency trade-o can be improved by introducing a (revenue-neutral) tax system which combines a suciently high  at rate (25%) and a lump-sum transfer paid only to formal workers; an expansionary policy (a reduction in total taxes or an increase in public expenditures). Interestingly, even though they increase the informal sector, these reforms reduce inequality and poverty through a reduction in the level of unemployment.

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