Promoting Firm Formalization in Minas Gerais, Brazil

Gustavo Henrique de Andrade (Governo do Estado de Minas Gerais) Miriam Bruhn (World Bank) David McKenzie (World Bank)

CIC – DIME Impact Evaluation Workshop

November 14, 2012

Firm Formalization Project Background Work with State Government of Minas Gerais in Brazil

According to the Brazilian Statistical agency (IBGE), 96% of firms were informal in 2003 (i.e. not registered with the government)

Why do we worry about informality? Lower tax revenue fewer resources for public services May prevent firms from growing (but we don’t know for sure)

Total # of firms # of informal firms

Brazil 10,525,954 10,335,962

Minas Gerais 1,088,064 1,049,774

Firms: Benefits and Costs of Formality Benefits Costs

Avoid government penalties Expand without fear of being shut down Legally enforceable agreements with suppliers and customers Issue receipts and expand customer base Access to new and lower cost sources of financing Access to government programs and contracts

Initial registration Monetary costs Admin. + opportunity costs of time and effort

Ongoing compliance Taxes, labor and other contributions Admin. + opportunity costs of time and effort

Descomplicar “Uncomplicate” Initiative

Launched by government of Minas Gerais in 2007 Goals Improve relationship between state and private sector Simplify regulation and reduce bureaucracy Encourage firm formalization Promote economic development

Business Registration Reform One of the first reforms was to simplify business registration One-stop-shop for completing municipal, state, and federal registration

procedures at the same time, in the same place (“Minas Fácil”)

Many Firms Remain Informal – Why? Firms are not aware that simplification

took place Other barriers to formalization

(registration fees, taxes) Lack of enforcement Is formalization beneficial for firms? Does

it improve firm performance?

Shed light on these issues with an impact evaluation that can inform which (complementary) policy actions to take in the future

Impact Evaluation Questions

Which intervention is most effective at encouraging firm formalization?

Providing information on costs and benefits of formalization, as well as on the simplified registration process

Providing information + lowering registration costs Stepping up inspections

If firms formalize as a result of the interventions, can also measure the impact of formalization on firm performance

Information Brochure 18 pages with information on

advantages and disadvantages of formalization, e.g. Access to credit Government contracts Taxes - how to calculate?

Also lists steps for registering

Was delivered to each firm in

person, with accompanying motivational speech

Information + Free Cost Registration

Along with information brochure, firms received a letter stating that they don’t have to pay fees if they register within the next 3 months Cost savings of about US$200

Registered firms are required to hire an accountant to

prepare tax declaration Provided pro-bono accountants for 1 year cost savings of

about US$1,800

Inspectors

Study was conducted in the city/municipality of Belo Horizonte (state capital of Minas Gerais)

Municipal inspectors visited firms to check whether they had the necessary municipal operating license (ALF)

Different layers of government mean municipal inspectors don’t enforce state and federal registration Firms can be partially formal

But, with Minas Facial one-stop-shop, firms automatically obtain state and federal registration if they get an ALF

Impact Evaluation Design Sample: List all informal firms in 600 city blocks Randomly divide 600 blocks into 3 groups

Measure effects by comparing experimental groups Control firms in information and inspector blocks allow

us to measure spillover effects Had to drop information spillover group later due to low

survey response (reduced sample size)

Block type # blocks

Control firms

Information only

Information + Free cost

Inspector Visits

Information 200 500 500 500 0

Inspector 200 500 0 0 500

Control 200 500 0 0 0

Project Timeline

Listing exercise

January/ February 2011

April 2011

Baseline survey

May – August 2011

October – December 2011

July - September 2012

Follow-up survey

Randomization Interventions

Administrative data on registrations

Baseline Data Baseline survey not conducted in inspector blocks

(for ethical reasons)

Since assignment to different study groups was random, baseline characteristics are basically identical No statistically significant differences

Control Information Information + Free Cost

Employees 1.1 1.3 1.3

Annual revenue (US$) 24,300 26,100 30,400

Business age (years) 7.8 8.1 8

Female owner 37% 37% 40%

Owner’s age (years) 44.3 44.4 44.1

Example of Firms in the Study

Follow-up Survey: Impact of Information and Free Cost Interventions

48

32

50 52

38

59 52

39

53

0

10

20

30

40

50

60

70

Federal State Municipal

%

Control Information Free cost

Percentage of firms reporting that they have the following types of registration

Stat

istic

ally

sig

nific

ant

Follow-Up Survey: Impact of Inspectors

64

49

65 68

57

68 65

50

69

0

10

20

30

40

50

60

70

80

Federal State Municipal

%

Control Inspector Inspector spillover

Percentage of firms reporting that they have the following types of registration

Stat

ist.

sign

ifica

nt

Why are so many firms registered in the control group?

Self-reported data, so results may not be accurate Now asking firms to provide registration numbers to check

whether they are indeed registered

Some firms have only one or two types of licenses, but not all, so are not fully formal

Could have included formal firms in the sample by mistake After listing, dropped firms from the sample that were on

registrar’s lists, but matching is difficult Officinal name different from name written outside the firm Not all firms have street numbers

Admin Data: Impact of Information and Free Cost Interventions

0.7

2.2

0.4

1.8

1.3

2.4

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Minas Facil Municipality (ALF)

%

Control Information Free cost

Percentage of firms that newly registered with…after intervention

Admin Data: Impact of Inspectors

0.6

1.8

1.0

4.9

0.5

1.8

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Minas Facil Municipality (ALF)

%

Control Inspector Inspector spillover

Percentage of firms that newly registered with…after intervention

Stat

istic

ally

sig

nific

ant

Preliminary Conclusions Information and free cost interventions did not promote

firm formalization according to admin data Still double-checking survey data

Inspections increased registration only for municipal licenses How is this possible with the one-stop-shop?

Firms may have been partially formal before (i.e. they already had a federal license)

Can’t measure impact of formalizing on firm performance since almost no firms formalized

Are the findings useful?

Yes! Information intervention did not have an effect Our co-author from the government said that knowing this

saves them a lot of money since otherwise might have tried to distribute information to all informal firms in Minas Gerais

Provides opportunity to focus on addressing other reasons why firms do not register…

Why don’t more firms register? (1/2) Registration

procedures are still somewhat complex, even after the simplification

Why don’t more firms register? (2/2) Firms need to pay taxes once they are registered…and

taxes seems to be particularly burdensome in Brazil