This paper develops an entry model with heterogeneous firms, where firms can exploit two margins of informality: (i) whether or not to register their business; and (ii) whether formal firms hire informal workers. The model is estimated using a two-step Method of Simulated Moments approach. Once the structural parameters have been estimated, the model is used to perform ex ante evaluations of three key policies: reducing formal sector’s entry costs; increasing enforcement of current institutions; and reducing payroll taxes. The results indicate that increasing enforcement can be effective in reducing informality but does not increase firms’ nor workers’ welfare, and it is not an effective strategy to increase productivity and allocative efficiency. On the other hand, reducing entry costs can achieve both higher levels of formalization and better aggregate outcomes. Workers are benefited by higher wages, while the individual effects on firms present a high degree of heterogeneity.