are unrelated and serve different markets or consumers (Harris & Todaro, 1970). The second biggest challenge is tax, which suggests that many firms in Indonesia might choose to stay informal to avoid paying taxes or given regulatory issues linked to the perceived complexity of the taxation system. Firm-level features will be updated and analyzed more thoroughly though as soon as the new business enterprise survey is completed in late 2023.

**4.2 Policy challenges associated with pervasive informality**

44. **Fiscal challenges are associated with more pervasive informality.** Over the period 2000-19, government revenues in EMDEs with above-median output informality were, on average, 4-5 percentage points of GDP below those with below-median output informality (figure 17; Ghossein, Yu, and Rana 2022). The composition of tax revenues is also tilted toward trade taxes in economies with more pronounced informality, making the tax system less progressive but facilitating tax collection when income underreporting is widespread. Similarly, in EMDEs with more pervasive output informality, government expenditures were 4-5 percentage points of GDP lower than in those with less output informality.

45. **Constrained government spending in EMDEs with more pervasive informality is reflected in the limited provision of public services, contributing to poorer human development outcomes** . During 2000-19, EMDEs with above-median output informality spent 2.6 percent of GDP on health, which was about 1 percentage point of GDP lower than in EMDEs with below-median output informality (figure 17; Ghossein, Yu, and Rana 2022). Similarly, governments in EMDEs with below-median output informality spent 1 percentage point of GDP more on education than EMDEs with above-median output informality. The lack of spending on education and health led to limited public resources in these sectors.<sup>18</sup> Meanwhile, compensation of government employees amounts to about a third of government expenses in EMDEs with abovemedian output informality, which is above the level in other EMDEs by 6 percentage points.

**Figure 17. Fiscal policies and informality**

<!-- Start of picture text --> A. Government revenues B. Government (primary) expenditure<br>Percent of GDP Percent of GDP / expenses<br>25 Below-median informality 35 Below-median informality<br>Above-median informality 30 Above-median informality<br>20 25<br>20<br>15<br>15<br>10<br>10<br>5<br>5 0<br>Total Education Health Gov. emp.<br>0 Compensation<br>Total Tax Income tax Trade tax (% expenses)<br><!-- End of picture text --> Sources: Elgin et al. (2021a) and Ghossein, Yu, and Rana (2022) .

Notes. Bars are simple averages over the period 2011-19 for EMDEs with above-median (high in blue; below-median, low in red) output informality. In all cases, blue bars are statistically different from red bars.

18 The average number of pupils per teacher in primary schools was about 35 in EMDEs with above-median informality—significantly higher, by eight students per teacher, than in EMDEs with below-median informality (Ohnsorge and Yu 2021). Access to medical resources, such as physicians and nurses, was also significantly more limited in EMDEs with a more pervasive informal sector (World Bank 2020).

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