This paper investigates the role of microentrepreneurship as a substitute for unemployment insurance in emerging economies. Using microenterprise surveys from Latin American countries, I document that a significant proportion of microentrepreneurs—ranging from 15% to 39%—start firms because they do not find jobs. These necessity entrepreneurs operate smaller, less profitable firms and experience higher income gains when transitioning to wage employment. I propose a two-sector model of occupational choice with labor market frictions, where workers can become self-employed to avoid unemployment. I calibrate the model for Mexico and show that self-insurance through self-employment decreases unemployment by 1.2 p.p. and reduces welfare losses due to unemployment risk by 22%. Consequently, enforcing costly taxes and regulations among informal microenterprises might harm workers’ ability to self-insure. Despite the presence of this additional channel of insurance, introducing a non-contributory unemployment insurance system increases welfare and is strongly progressive.

We develop a dynamic general equilibrium model with heterogeneous households and a cash-intensive informal sector that replicates two empirical patterns: the negative relationship between informality and firm productivity, and the declining share of informal consumption with household wealth. The non-homotheticity of informal consumption implies that tax incidence is heterogenous: poor households pay less consumption taxes but are more exposed to inflation. We use the model to study the distributional effects of financing government revenue through seigniorage versus consumption taxes. Calibrated to Peru – where informality accounts for around half of economic activity – the model shows that informal purchases provide significant savings through lower prices, particularly for poor households, who save up to 11% compared to purchasing the same bundle formally. The model also uncovers substantial variation in preferences over revenue-neutral combinations of inflation and consumption taxes: households in the top decile would like inflation to be as high as 12%, while those in the bottom decile favor inflation below 5%. This disagreement grows with the size of the informal sector.