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 Brazil10,525,95410,335,962 Minas Gerais1,088,0641,049,774

Firms: Benefits and Costs of Formality BenefitsCosts 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 Inspector Control

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 ControlInformationInformation + Free Cost Employees Annual revenue (US$)24,30026,10030,400 Business age (years) Female owner37% 40% Owner’s age (years)

Example of Firms in the Study

Follow-up Survey: Impact of Information and Free Cost Interventions  Percentage of firms reporting that they have the following types of registration Statistically significant

Follow-Up Survey: Impact of Inspectors  Percentage of firms reporting that they have the following types of registration Statist. significant

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  Percentage of firms that newly registered with…after intervention

Admin Data: Impact of Inspectors  Percentage of firms that newly registered with…after intervention Statistically significant

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