economic incidence of PIT and SIC does not fall on employees); scenario B, α = β = 1 (i.e., economic incidence of both PIT and SIC fully falls on employees); and scenario C, α = 0, β = 1 (i.e., economic incidence coincides with statutory, SIC falls on employer, PIT falls on employees). In some cases, net wages remain unchanged, in others they increase (scenario B for those who remain formal) and in others they fall (scenarios B and C for those who formalize).

The second channel refers to changes in public benefits and the amount of VAT paid. Changes in benefits may lead either to increase or decrease of the disposable income as they could be driven by two reasons: (i) households may lose gain/eligibility if the formal income decreases/increases (for example, for means-tested _state social assistance_ ) or the amount might change if it depends on the previous formal income (for example, for _maternity leave allowance_ ). The VAT is assumed to be always paid by consumer and the changes in the disposable income are directly transferred to changes in expenditures that are taxed with higher VAT rate. That is why it always leads to reduction in consumable income.<sup>20</sup> The final change in consumable income depends on combination of all abovementioned factors and could be positive, negative or neutral depending on the characteristics of the specific household. It is also worth mentioning that all numbers produced by RUSMOD are in per capita terms, meaning that all individual incomes are summed up within the household and divided by the household size. That is why even not working individuals may benefit from changes in wages and/or benefits that are assigned to other members of the household. The second channel may, or may not, partly compensate for the negative effect of the first one since people who will start paying higher direct taxes will have smaller disposable income, and, therefore, may become eligible for some means-tested programs.

**Table 4: Impact on net wages by simulation scenario**

||Assumptions ab<br>|out the economic incidence of<br> <br><br>|PIT and SIC:<br>|
|---|---|---|---|
|Reform options:<br>Informality Status:|A. SIC and PIT not on<br>employees|B. SIC and PIT on<br>employees<br><br> <br><br>|C. SIC on employers,<br>PIT on employees|
|1. Formal - Formal|W<sup>a</sup>1= W<sup>a</sup>0<br>No changes in net wages.|W1<br>a= W0<br>a <sup>(1−t−s</sup>1<sup>)</sup><br>(1−t−s0)<br>Net wage grows due to<br>reduction in SIC rate.|W<sup>a</sup>1= W<sup>a</sup>0<br>No<br>changes<br>in<br>net<br>wages.|
|2. Informal - Informal|W<sup>a</sup>1= W<sup>a</sup>0<br>No changes in net wages.|W<sup>a</sup>1= W<sup>a</sup>0<br>No changes in net wages.|W<sup>a</sup>1= W<sup>a</sup>0<br>No<br>changes<br>in<br>net<br>wages.|
|3. Informal - Formal|W<sup>a</sup>1= W<sup>a</sup>0<br>No changes in net wages.|W<sup>a</sup>1= W<sup>a</sup>0*(1 - t - s1).<br>Reduction in net wages<br>due to obligation to pay<br>SIC and PIT.|W<sup>a</sup>1= W<sup>a</sup>0*(1 - t).<br>Reduction in net wages<br>due to obligation to pay<br>PIT.|

The simulated changes in the distributional and budgetary outcomes under reform 1 scenarios are shown in Table 5. Quite predictably, all reform 1 scenarios under which some or all workers formalize and start paying SIC and PIT, keeping the existing tax-benefit rules, would be beneficial for the budget, irrespective of the assumptions about the distribution of tax incidence. The maximum budget increase among those reported below (in case of transition of 50 percent of informal workers to formality) would be quite significant, varying from 0.9 percent of the GDP under scenario B, to 1.0

> 20 The distinction between disposable and consumable income comes from Lustig (2018). See Figure 1.

21