Chapter 3 Who Benefits from Reducing the Cost of Formality? Quantile Regression Discontinuity Analysis

This chapter studies the effect of increasing formality via tax reduction and simplification schemes on micro-firm performance. We develop a simple theoretical model that yields two intuitive results. First, low- and high-ability entrepreneurs are unlikely to be affected by a tax reduction and therefore, the reduction has an impact only on a segment of the micro-firm population. Second, the benefits to such reduction, as measured by profits and revenues, are increasing in the entrepreneur's ability. Then, we estimate the effect of formality on the entire conditional distribution (quantiles) of revenues using the 1996 Brazilian SIMPLES program and a rich survey of formal and informal micro-firms. The econometric approach compares eligible and non-eligible firms, born before and after SIMPLES in a local interval about the introduction of SIMPLES. We develop an estimator that combines both quantile regression and the regression discontinuity design. The econometric results corroborate the positive effect of formality on micro-firms’ performance and produce a clear characterization of who benefits from these programs.