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

By David J. McKenzie, Y. Sakho. Social Science Research Network, 2008

327 citations recorded by the source corpus.

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 the authors to control for a rich set of measures of owner ability and business motivations that can affect both profits and the decision to formalize. The paper identifies 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. The findings show that tax registration leads to significantly higher profits for the firms that the instrument affects. However, there is also evidence of heterogeneous effects of tax formality on profits. Tax registration is found to increase profits for the mid-size firms in the sample, but to lower profits for both the smaller and larger firms, in contrast to the standard view that formality increases profits. The analysis shows that owners of large firms who have managed to stay informal have higher entrepreneurial ability than formal firm owners, in contrast to the standard view (correct among smaller firms) that informal firm owners have low ability.

Subfields: Accounting, Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/9ab6c124f73e2763a130fe184e6739d70ceadf70

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Citations in the corpus

Closing the Credit Gap for Formal and Informal Micro, Small, and Medium Enterprises (2013, unknown): “21 Bangladesh Firm Census (2010) conducted by EGI, with a sample size of 55,817 firms (McKenzie and Rahman, 2010) and Sri Lanka Firm Census (2008) conducted by the Sri Lanka Longitudinal Survey of Enterprises (SLLSE), with a sample of 2,865 firms (de Mel et al., 2012a).”
Taxing the Informal Economy: The Current State of Knowledge and Agendas for Future Research (2014, background): “McKenzie and Sakho (2010) examine micro firms in Bolivia, using distance from the tax office as an instrument for informality, in an effort to establish the causal role of formalisation.”
Entry Regulation and the Formalization of Microenterprises in Developing Countries (2013, methodology): “For example, McKenzie and Sakho (2010) use an instrumental variables method to measure the consequences of being formal in Bolivia, arguing that firms that are closer to the municipal tax office have more information and lower costs of registering than similar firms located elsewhere in the same…”
The Benefits of Formalization: Evidence from Vietnamese Manufacturing SMEs (2012, methodology): “In an earlier version of this paper we analyzed several other outcome variables in order to test whether formality increases the private sector customer base (through the ability of formal firms to issue tax receipts, see McKenzie and Sakho, 2010 for details).”
Can Informal Firms Hurt Registered SMEs’ Access to Credit? (2016, unknown): “McKenzie and Sakho (2010) find that owners of large informal firms have higher entrepreneurial ability than formal firm owners.”
Informal Entrepreneurship in Developing Economies: The Impacts of Starting up Unregistered on firm Performance (2017, background): “McKenzie and Sakho (2010) in Bolivia and McCulloch, Schulze, and Voss (2010) in rural Indonesia find that registration only increases firm profitability and sales growth for mid-sized firms, suggesting that delaying registration until firms reach a certain size may be optimal.”