Does it Pay Firms to Register for Taxes? The Impact of Formality on Firm Profitability

31 Pages Posted: 3 Dec 2007

See all articles by David J. McKenzie

David J. McKenzie

World Bank - Development Research Group (DECRG); IZA Institute of Labor Economics

Yaye Seynabou Sakho

World Bank

Multiple version iconThere are 2 versions of this paper

Date Written: November 2007

Abstract

This paper estimates the impact of registering for taxes on firm profits in Bolivia, the country with the highest levels of informality in Latin America. A new survey of micro and small firms enables us to control for a rich set of measures of owner ability and business motivations that can affect both profits and the decision to formalize. We identify the impact of tax registration on business profitability using the distance of a firm from the tax office where registration occurs, conditional on the distance to the city center, as an instrument for registration. Proximity to the tax office provides firms with more information about registration, but is argued to not directly affect profits. We find tax registration leads to significantly higher profits for the firms that the instrument affects. However, we also find evidence of heterogeneous effects of tax formality on profits. Tax registration is found to increase profits for the mid-sized firms in our sample, but to lower profits for both the smaller and larger firms, in contrast to the standard view that formality increases profits. We show that owners of large firms who have managed to stay informal are of higher entrepreneurial ability than formal firm owners, in contrast to the standard view (correct among smaller firms) that informal firm owners are low ability.

Keywords: informal sector, entrepreneurial ability, tax registration

JEL Classification: O17, O12, D21

Suggested Citation

McKenzie, David John and Sakho, Yaye Seynabou, Does it Pay Firms to Register for Taxes? The Impact of Formality on Firm Profitability (November 2007). IZA Discussion Paper No. 3179, Available at SSRN: https://ssrn.com/abstract=1048081

David John McKenzie (Contact Author)

World Bank - Development Research Group (DECRG) ( email )

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
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IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Yaye Seynabou Sakho

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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