Developing countries have a vast informal sector generally associated with low productivity levels. The informal employment persistence could respond to rigidities in the labor market and the lack of a combination of labor policies and state capacity. This paper proposes a theoretical framework to understand the role of tax policies that discourage informality, such as lower payroll taxes in the formal sector or increased enforcement expenditure, in an economy with real wage rigidities. I develop a search and matching model with a shirking mechanism for formal and informal workers. The analytical results show that decreasing payroll taxes increases formal employment demand, and enforcement expenditure decreases informal employment offers. The model suggests that a tax policy combination leads to a significant impact on informality reduction. Furthermore, the flexibility of real wage rigidities could significantly decrease informal employment. On the other hand, the tax policies' magnitude effect depends on real wage rigidities. When the economy is in front of high real wage rigidities, the tax policies have a higher effect on informality reduction than those with low real wage rigidities. However, with fewer real wage rigidities, there is an increase in tax revenue through tax policies, affecting less formal employment.
