How to promote the formalization of entrepreneurs in Latin America

There are more than 10 million micro and small enterprises in Latin America. These productive units generate most of the employment in the region but, at the same time, concentrate the highest levels of informality. 

With the objective of answering questions regarding the causes that determine this phenomenon, what policies could revert it, and what, if any, would be the impact of formalization on the productive units, CAF, Development Bank of Latin America, jointly with Fundempresa and the ARU Foundation, carried out a study with a group of 1046 microentrepreneurs located in El Alto and La Paz, Bolivia.

The starting point of the study was a base line survey (ARU, 2013), carried out in April 2012, which identified the fact that these companies did not know the procedures to formalize. In addition, it determined that they did not know exactly how much taxes they would have to pay given their characteristics. With this information in hand, the surveyed establishments were divided randomly into three groups of similar sizes. 

Due to the lack of information, a multiple "information shock" was considered for the first group, by providing them with an informative calendar. In addition to the information shock, the second group was provided with a subsidy to obtain a commercial registry (a three month "voucher" with a 50 percent reduction in the registry costs of Fundempresa). The third group represented the control group and did not receive any incentive. 

The following year, visits were planned to the establishments to make a second survey that allowed to explore the medium-term impact of the interventions. An analysis of the results showed that both treatment groups had a greater disposition to obtain the commercial registry. However, the effects varied according to the characteristics of the entrepreneurships. Larger firms, which were informed that they had to submit to a more severe tax regime, stopped obtaining the RIF, reduced their accounting registries, and decreased the transactions through the financial system, evidencing that the intention to hide from the Internal Revenue System could increase. 

It was also observed that in the measures corresponding to "sales" and "holding of capital" companies grew. Researchers suggest that this could have a "glow in the dark" effect, as it reflects the companies' motivation to sell more, forcing them to increase their capital while at the same time avoiding formal transactions. 

Finally, it was determined that information shocks, complemented with an incentive, may condition the assimilation of information or the attention that entrepreneurs give to communications. The voucher discount positively conditioned the assimilation of information and generated different effects (greater disposition to obtain the commercial registry), which were not expected in the beginning. 

Designing and implementing policies that help increase the fraction of the economy that functions in the formal sector may help increase tax collection and may have important effects on the long-term productivity of countries. This study is particularly important in a region where one out of two workers has informal jobs, and where an important fraction does not have access to health insurance or retirement pensions.