Does formality improve micro-firm performance? Evidence from the Brazilian SIMPLES program

• Published in: Journal of development economics Vol. 94; no. 2; pp. 262 - 276
• Main Authors: Fajnzylber, Pablo, Maloney, William F., Montes-Rojas, Gabriel V.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-03-2011; Elsevier; Elsevier Sequoia S.A
• Series: Journal of Development Economics
• Subjects: Brazil; Business Taxes and Subsidies including sales and value-added (VAT) H250; Capacity D240; Capital stock; Capital, Total Factor, and Multifactor Productivity; Corporate taxation; Cost; Economic performance; Employment; Financial performance; Formal and Informal Sectors; Informality; Institutional Arrangements O170; Labor Demand J230; Micro-firms; Micro-firms Self-employment Informality; Production; Profitability; Regulation; Revenue; Self-employed workers; Self-employment; Shadow Economy; Small and medium sized enterprises; Small business; Studies; Tax cuts; Tax rates; Tax regulations; Brazil; Self-employment; J23; Informality; L25; Micro-firms
• ISSN: 0304-3878; 1872-6089
• DOI: 10.1016/j.jdeveco.2010.01.009

This paper exploits an extensive Brazilian micro-enterprise survey and the 1996 introduction of a business tax reduction and simplification scheme (SIMPLES) to examine three questions. First, do high tax rates and complex tax regulations really constitute a barrier to the formalization of micro-firms? Second, does formalization improve firm performance measured along several dimensions, including revenues, employment and capital stock? Third, what are the channels through which this occurs? We find that SIMPLES led to a significant increase in formality in several dimensions. Moreover, newly created firms that opt for operating formally show higher levels of revenue and profits, employ more workers and are more capital intensive (only for those firms that have employees). The channel through which this occurs is not access to credit or contracts with larger firms. Rather, it appears that the lower cost of contracting labor leads to adopting production techniques that involve a permanent location and a larger paid labor force.