In a sample of developing countries, 19% of microentrepreneurs report starting their businesses because they could not find jobs. Consistent with a self-insurance motive, these “necessity microentrepreneurs” are more likely to transition from unemployment and run smaller and less profitable firms. To study the aggregate implications of self-employment functioning as a last resort income, I develop an occupational choice model where risk-averse workers can resort to informal microentrepreneurship to smooth income risk from unemployment. Enforcing entry regulations can reduce welfare even while increasing output. Despite limited state capacity, introducing unemployment insurance increases welfare and is strongly progressive.

Low-income households in developing countries devote a larger share of spending to informal, cash-intensive goods. As a result, consumption taxes fall more heavily on the rich, whose spending is concentrated in the taxable formal sector, while inflation falls more heavily on the poor, who rely more on cash. To quantitatively evaluate the distributional consequences of both instruments, we develop a heterogeneous-agent model with a cash-intensive informal sector and a rich description of the goods market that yields the aforementioned non-homothetic consumption patterns. Calibrated to Peru – where informality accounts for around half of eco- nomic 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. In revenue-neutral reforms that trade off inflation against consumption taxes, we uncover sharp distributional conflict: households in the bottom decile prefer an 18% consumption tax rate with 4% inflation, whereas the top decile prefers a 13% consumption tax rate with 12% inflation. The disagreement grows with the size of the informal sector.