IV. Is lack of formalisation simply due to misinformation about the costs of formalisation?

Before discussing the impact of reforms that simplify the business formalisation process, a natural first question arises: do firms have incorrect opinions about the cost of formalisation? Would an intervention that simply provided them with the correct information increase formalisation rates? Overall, although there is evidence that firms are not well informed about the process of formalising or the costs involved, most studies have found that simply providing information does not lead to a large increase in formalisation.

In Sri Lanka, de Mel, McKenzie, and Woodruff (2013) report that only 17 percent of informal firm owners in their study knew the cost of registering and that most believed that the process of formalising would take more than a month (in practice, it took a week or less). Moreover, only 2 percent knew that lower business incomes are not liable for tax. In Bolivia, McKenzie and Sakho (2010) report that only one-third of informal owners knew the location of the tax office, which is where business registration takes place, and only 10 percent had even heard of the commerce registry.

A natural policy response to this lack of knowledge is to provide information to firms on how they can register, and the potential benefits of registration. However, several experiments show that providing information alone results in no increase in formalisation. In Brazil, Andrade, Bruhn, and McKenzie (2014) provided an information brochure that was prepared by a state government marketing team to 208 informal firms. They find that the recipient firms were not more likely to register over the following year. In Bangladesh, de Giorgi and Rahman (2013) provided 1,500 informal firms with information and brochures, finding that fewer than 5 percent of them registered, a share not larger than the percentage registering among the control group who were not given any information. In Benin, Benhassine, McKenzie, Pouliquen, and Santini (2018) also use a field experiment and find that few firms registered when just given information about the introduction of a new simplified business registration scheme.

Two randomised experiments have investigated the impact of lowering the cost of formalisation in addition to providing information. In Sri Lanka, de Mel, McKenzie, and Woodruff (2013) provided information and offered to reimburse the full cost of registering for taxes to 104 firms, and found that only one firm accepted the offer and formalised. In Brazil, Andrade, Bruhn, and McKenzie (2014) provided information and to 225 informal firms. The government agreed to waive all registration costs as well as sanitary and inspection taxes, and the researchers agreed to pay for accountants to prepare the required forms. Only one firm accepted the offer. This evidence suggests that the cost of registering has very little impact on the registration of existing firms. One reason for this may be that, as well as the initial cost, registration increases the expected ongoing costs, increasing taxes and labour costs directly and adding costs of accountants and other fees that are required for complying with tax and labour regulations.

In many countries, formalisation also requires registration with other government agencies, such as the municipal license agency. In Peru, Alcázar, Andrade, and Jaramillo (2010) investigate the impact of a reform that reduced the time to obtain a municipal license from 160 days to 2 days. The authors use a randomised experiment to offer 300 informal firms a subsidy of between 27 and 35 percent of the cost of a municipal license, and find that it led to approximately 10 to 12 percent of informal firms obtaining a license. In Malawi, Campos, Goldstein, and McKenzie (2018) separately investigate the effect of business and tax registration to test whether governments can bring firms into at least part of the formal system. They conduct a randomised experiment with 3,000 informal firms and three different treatments: (i) 745 firms were offered assistance obtaining a business registration certificate at no cost; (ii) 293 firms were offered assistance in obtaining both the business registration certificate and a tax payer identification number; and (iii) 1,207 firms received assistance in obtaining a business registration certificate plus a bank information session. Business registration increased by a large amount for all three treatments (with 75% of firms registering their business), with no significant effect on tax registration in any of the treatments. Assisting firms with information on bank accounts led to a 39 percentage point increase in bank account usage, which in turn led to a 15 percent growth in profits.

Overall, the results discussed in this section suggest that, while there is evidence that many firms are not well informed about the process of formalising, information alone does not lead to a large effect on formalisation rates. Assisting firms with the registration process can lead to a greater effect, for example by separating the business and tax registration process, and by assisting firms in benefiting from their new status.

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