Abstract
Do firms pay more taxes after formalization? The answer to this question is nontrivial. Tax noncompliance can be a persistent behavior among formerly informal firms. Analyzing the relationship between formalization and tax payments can also be challenging if nonswitching and switching firms have different characteristics. I use a panel dataset built from five small and medium-sized enterprise surveys conducted in Viet Nam from 2005 to 2013. By comparing nonswitching informal firms to switchers, I show that switchers are more likely to pay taxes and to pay a higher amount, thereby confirming heterogeneity. By comparing switchers before and after formalization, I find that formalization increases tax payment likelihood by 20% and the tax amount paid by 93%. A control function approach indicates that my results are robust to potential endogeneity of formalization. Therefore, this paper provides supportive evidence for a key public policy rationale to promote formalization: increased tax revenues.
Highlights
The results suggest that becoming formal is positively and significantly associated with an increased likelihood to pay taxes when looking at the coefficient of switcher
To explore where the increase in tax payments after formalization comes from, I make a distinction between revenue taxes and other taxes, with the latter obtained by excluding revenue taxes from total tax payments
Using a panel dataset consisting of five waves of small and medium-sized enterprises (SMEs) surveys in Viet Nam, this paper analyzes the relationship between formalization and tax payments
Summary
Existing research has mainly focused on the private costs and benefits of formalization for informal firms, with available evidence suggesting that formalization can have a positive effect on firm performance (McKenzie and Sakho 2010; Fajnzylber, Maloney, and Montes-Rojas 2011; Rand and Torm 2012; Bruhn and McKenzie 2014; Boly 2018). In contrast to most previous studies, this paper. Existing research has mainly focused on the private costs and benefits of formalization for informal firms, with available evidence suggesting that formalization can have a positive effect on firm performance (McKenzie and Sakho 2010; Fajnzylber, Maloney, and Montes-Rojas 2011; Rand and Torm 2012; Bruhn and McKenzie 2014; Boly 2018).. The switcher variable, as firm-type fixed effects, allows for capturing heterogeneity between firms remaining informal and firms that switched out of the informal sector at some point. By comparing switchers before and after formalization, I find that formalization increases the likelihood of tax payment (by 20%) and the amount of taxes (by 93%) relative to preformalization levels.
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