PROJECT

THE TRUE COSTS OF INCENTIVIZING SMALL FIRMS TO FORMALIZE IN DEVELOPING COUNTRIES

Researcher: Francois Gerard

Many small and medium-size businesses in developing countries conceal all or part of their economic activity from the government, and high levels of “informality” are viewed as a major constraint on economic growth. Taxes and compliance costs are often blamed as a main cause of informality in policy debates. Preferential tax schemes for small and medium size businesses, characterized by lower tax rates and compliance costs, have thus been implemented in a number of countries to spur formalization of businesses and their workforce. However, there is limited evidence to inform policymakers on the actual impacts of such policies. Researchers rarely have access to the data necessary to credibly estimate the fiscal costs and economic impacts of these policies for eligible firms. Moreover, to estimate the true costs and impacts, one must also quantify displacement effects: these policies can distort economic activity away from ineligible firms that are subject to the usual tax system. In practice, it is very challenging to find a suitable research design to estimate such effects and to have access to the data to implement it. In this project, the researchers will address these two limitations by studying the fiscal and economic impacts of the SIMPLES program, the major preferential tax scheme for small and medium-size businesses in Brazil. The researchers will be able to exploit policy variations over time (the revenue threshold for eligibility was doubled in 2012) and unique administrative data (through a research collaboration with the tax authority of the state of Rio de Janeiro) to study both direct effects for eligible firms and displacement effects.