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

42 Pages Posted: 18 May 2013

See all articles by Gustavo Henrique de Andrade

Gustavo Henrique de Andrade

Governo do Estado de Minas Gerais

Miriam Bruhn

World Bank - Development Research Group (DECRG)

David J. McKenzie

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

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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.

Keywords: informality, enforcement, small enterprises

JEL Classification: O17, O12, C93, D21, L26

Suggested Citation

de Andrade, Gustavo Henrique and Bruhn, Miriam and McKenzie, David John, A Helping Hand or the Long Arm of the Law? Experimental Evidence on What Governments Can Do to Formalize Firms. IZA Discussion Paper No. 7402, Available at SSRN: https://ssrn.com/abstract=2266829

Gustavo Henrique De Andrade

Governo do Estado de Minas Gerais

Portugal

Miriam Bruhn

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

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

David John McKenzie (Contact Author)

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

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

IZA Institute of Labor Economics ( email )

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

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