I investigate the role played by microentrepreneurship as an income of last resort. Using microenterprise surveys from developing countries, I document that, on average, 19% of microentrepreneurs start firms because they do not find jobs. Relative to the rest, these `necessity microentrepreneurs’ are more likely to come from unemployment, run smaller and less profitable firms, and earn larger income gains when transitioning to wage employment, consistent with a self-insurance motive. To evaluate the channel’s aggregate implications, I propose a two-sector model of occupational choice with labor market frictions, where risk-averse workers separated from wage work can resort to informal microentrepreneurship to avoid unemployment. I find that enforcing entry regulations among microentrepreneurs may reduce welfare even if it increases output. Despite significant challenges due to limited state capacity, introducing unemployment insurance 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.