Quantifying the Impacts of Expanding Social Protection on Efficiency and Equity: Evidence from a Behavioral Microsimulation Model for Ghana

A key challenge facing developing countries when they are gradually building up their social protection system is the presence of a large informal sector. Social safety nets should be expanded to reduce poverty, but financing social protection through higher taxes may reduce the number of formal-sector jobs available. The aim of this paper is to quantify the impacts of a revenue-neutral expansion of social protection in a developing country on both income distribution and efficiency which we measure via the impacts on formal sector work. Results from a new tax-benefit microsimulation model for Ghana, GHAMOD, are combined with the extensive margin elasticity of the share of formal work with respect to the tax wedge on formal labour, derived from repeated cross-section econometric estimates. The size of the estimated formality elasticity is modest and therefore the distributional gains of expanding cash transfer programmes are considerable, even when taking into account behavioural impacts.