Does Corruption Affect the Informal-Formal Sector Income Gap? Evidence from Brazil

Abstract This paper examines the association between political corruption and the informal-formal sector income gap. We focus on a sample of 476 randomly selected municipalities in Brazil, and combine individual level Census data with measures of municipal corruption. We first document that higher levels of corruption are correlated with a wider informal-formal income gap. To address potential endogeneity, we employ a measure of mismanagement by governmental officials as an instrument for corruption, providing evidence that the observed relationship is consistent under alternative identification strategies. When we disaggregate by industry, the results suggest that the association between corruption and the income gap varies across sectors, appearing strongest in construction.