Coming out of the shadows? Estimating the impact of bureaucracy simplification and tax cut on formality in Brazilian microenterprises

a r t i c l e i n f o This paper evaluates the impact of a program of bureaucracy simplification and tax reduction on formality among Brazilian microenterprises — the SIMPLES program. We document an increase of 13 percentage points in formal licensing among retail firms created after the program when compared to firms in ineligible sectors. The impact on retailers is robust to a series of tests. We find no impact on construction, transportation, services and manufacturing sectors. In most countries, a substantial portion of the GDP is produced by the so-called shadow or underground economy. In Latin America, for example, the size of the informal sector relative to official GDP ranges from 25% to 50%. For OECD countries, underground activities account, on average, for 16% of GDP (Enste and Schneider (2000)). A large body of literature addresses the measurement of the shadow economy. Many contributions are published in a special issue of the Economic Journal (109:456, June 1999) and a survey of the different methodologies and main estimates can be found in Enste and Schneider (2000). However, less attention has been devoted to the causes and consequences of informality. Empirical evidence about key determinants is still very scattered due, predominantly, to the absence of data. As mentioned by Enste and Schneider (2000), " gathering information about underground economic activity is difficult, because no one engaged in such activity wants to be identified ". This paper evaluates the effects of new bureaucracy simplification and tax reduction legislation for micro and small firms in Brazil — the so-called SIMPLES system. The analysis of SIMPLES program offers a great opportunity to contribute to the literature on determinants of informality because the program promotes a sizeable reduction in tax burden and reduces the red tape involved in tax payments, and therefore bypassing cumbersome procedures that increase the costs of being formal. Our evidence is based on a special cross-sectional survey of micro and small firms conducted in 1997, less than one year after the implementation of the program. This database along with the implementation of this new taxation in Brazil provides an opportunity for investigating the informal economy at the firm level. The identification strategy is based on a few key aspects of the empirical environment. First, the new tax system is restricted to a subset of sectors. We explore this characteristic using a difference-indifference approach , comparing the legal …