This paper develops a four-sector equilibrium search and matching model with informal sector employment opportunities and educational choice. We show that underground activities reduce educational attainments if informal employment opportunities mainly are available for low-educated workers. A more zealous enforcement policy will in this case improve educational incentives as it reduces the attractiveness of remaining a low-educated worker. However, unemployment also increases. Characterizing the optimal enforcement policies, we find that relatively more audits should be targeted towards the sector employing low-educated workers; elsewise, a too low stock of educated workers is materialized.
- Tax evasion
- The informal sector