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A Helping Hand or the Long Arm of the Law? Experimental Evidence on What Governments Can Do to Formalize Firms

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Author Info

  • de Andrade, Gustavo Henrique

    (Governo do Estado de Minas Gerais)

  • Bruhn, Miriam

    ()
    (World Bank)

  • McKenzie, David

    ()
    (World Bank)

Abstract

Many governments have spent much of the past decade trying to extend a helping hand to informal businesses by making it easier and cheaper for them to formalize. Much less effort has been devoted to raising the costs of remaining informal, through increasing enforcement of existing regulations. We conducted a field experiment in Belo Horizonte, Brazil, in order to test which government actions work in getting informal firms to register. Firms were randomized to a control group or one of four treatment groups: the first received information about how to formalize; the second received this information and free registration costs along with the use of an accountant for a year; the third group was assigned to receive an enforcement visit from a municipal inspector; while the fourth group was assigned to have a neighboring firm receive an enforcement visit to see if enforcement has spillovers. We find zero or negative impacts of information and free cost treatments, and a significant but small increase in formalization from inspections. Our LATE estimates of the impact of actually receiving an inspection are much bigger, giving a 21 to 27 percentage point increase in the likelihood of formalizing. The results show most informal firms won't formalize unless forced to do so, suggesting formality offers little private benefit to them, but the tax revenue benefits to the governments of bringing firms of this size into the formal system more than offset the costs of inspections.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 7402.

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Length: 42 pages
Date of creation: May 2013
Date of revision:
Handle: RePEc:iza:izadps:dp7402

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Keywords: informality; enforcement; small enterprises;

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  1. McKenzie, David & Sakho, Yaye Seynabou, 2007. "Does it pay firms to register for taxes ? the impact of formality on firm profitability," Policy Research Working Paper Series 4449, The World Bank.
  2. Marianne Bertrand & Francis Kramarz, 2002. "Does Entry Regulation Hinder Job Creation? Evidence From The French Retail Industry," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1369-1413, November.
  3. Kaplan, David S. & Piedra, Eduardo & Seira, Enrique, 2011. "Entry regulation and business start-ups: Evidence from Mexico," Journal of Public Economics, Elsevier, vol. 95(11), pages 1501-1515.
  4. David Kaplan & Eduardo Piedra & Enrique Seira, 2007. "Are Burdensome Registration Procedures an Important Barrier on Firm Creation? Evidence from Mexico," Working Papers 0701, Centro de Investigacion Economica, ITAM.
  5. Suresh de Mel & David McKenzie & Christopher Woodruff, 2013. "The Demand for, and Consequences of, Formalization among Informal Firms in Sri Lanka," American Economic Journal: Applied Economics, American Economic Association, vol. 5(2), pages 122-50, April.
  6. Rafael La Porta & Andrei Shleifer, 2008. "The Unofficial Economy and Economic Development," NBER Working Papers 14520, National Bureau of Economic Research, Inc.
  7. Alm, James & McClelland, Gary H. & Schulze, William D., 1992. "Why do people pay taxes?," Journal of Public Economics, Elsevier, vol. 48(1), pages 21-38, June.
  8. Klapper, Leora & Laeven, Luc & Rajan, Raghuram, 2006. "Entry regulation as a barrier to entrepreneurship," Journal of Financial Economics, Elsevier, vol. 82(3), pages 591-629, December.
  9. Fajnzylber, Pablo & Maloney, William F. & Montes-Rojas, Gabriel V., 2011. "Does formality improve micro-firm performance? Evidence from the Brazilian SIMPLES program," Journal of Development Economics, Elsevier, vol. 94(2), pages 262-276, March.
  10. Lucas Ronconi, 2010. "Enforcement and Compliance with Labor Regulations," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 63(4), pages 719-736, July.
  11. Bruhn, Miriam, 2008. "License to sell : the effect of business registration reform on entrepreneurial activity in Mexico," Policy Research Working Paper Series 4538, The World Bank.
  12. John Gibson & David McKenzie, 2007. "Using the Global Positioning System (GPS) in Household Surveys For Better Economics and Better Policy," Working Papers in Economics 07/04, University of Waikato, Department of Economics.
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