We supposed it was possible to impose a tax in these sectors, and marginally increased the tax from an initial rate of zero. We calculated MCFs when 1% taxes were imposed on: production of the _untaxed_ good ( _U_ ); _informal capital_ used anywhere in the economy ( _K_<sup>_i_</sup> ); _informal capital_ used to produce _domestic_ or _export_ goods ( _KDE_<sup>_i_);</sup><sup>_informallabor_usedanywhereintheeconomy(</sup><sup>_Li_);and</sup> _informal labor_ used to produce _domestic_ or _export_ goods( _L_<sup>_i_</sup> _DE_<sup>).Wedistinguished</sup> between taxing a factor wherever it is used and taxing a factor when it is used to produce _domestic_ or _export_ goods because the latter seems more plausible. It seems more likely that the administration will be able to tax a firm’s accounting profits (returns to capital) and labor inputs in cases where the firm’s output is already taxed. The results of these experiments are reported in Table 6.

In all countries the MCF of a tax on the _untaxed_ good is less than 1. The negative welfare shock suffered by households (before the revenue is returned lump-sum) is smaller than the increase in government revenue. Once lump-sum redistribution of the revenue occurs, households are better off than before the tax shock. Increasing taxes in the informal sector helps to counteract existing taxes in other sectors, moving relative prices towards their undistorted levels.

When taxation of informal factors is restricted to inputs to _domestic_ and _export_ goods, the MCF is higher than when informal factors are taxed wherever they are used: _MCF_ ( _KDE_<sup>_i_)</sup><sup>_>MCF_(</sup><sup>_Ki_)and</sup><sup>_MCF_(</sup><sup>_Li_</sup> _DE_<sup>)</sup><sup>_>MCF_(</sup><sup>_Li_).</sup> Two effects operate. Taxing an untaxed factor helps to restore prices to their undistorted levels, tending to lower the MCF. When the untaxed factors are inputs to taxed goods, the relative costs of these goods rise, the distortion associated with goods taxation increases and the MCF tends to be higher. The second of these effects is relatively stronger when the tax shock is concentrated on inputs to _domestic_ and _export_ goods.

Ignoring distributional issues, on average among the fictional tax instruments for taxing the informal sectors, the best way of raising money is by increasing taxes on _untaxed_ goods. The average _MCF_ ( _U_ ) is 0.87, lower than the average MCF elsewhere in the informal economy.

But governments may hesitate to increase taxes of the informal sector if they care about distributional issues and poor households are concentrated in production of _untaxed_ goods or they consume a lot of _untaxed_ goods. When distributional issues are considered, a promising part of the informal economy is _informal capital_ used to produce taxed goods: average _MCF_ ( _KDE_<sup>_i_) is 1.05.That is, imposing taxes</sup> on companies that produce taxed goods but do not pay company tax generally offers a lower cost of public funds than increasing existing taxes elsewhere in the formal economy. In many cases such companies have legal tax exemptions, which can be removed with low administrative expense.<sup>17</sup> Removing such exemptions has the 17In a survey of 197 businesses in Cameroon, Gauthier & Gersovitz (1997) report that 4 were legally exempt from sales tax, while 30 were legally exempt from the business profits tax. In Gauthier & Reinikka (2001) a similar survey of 158 businesses in Uganda reports 17 exemptions from sales tax and 41 exemptions from the corporate income tax. Both 22