De Mel, Suresh; McKenzie, David; Woodruff, Christopher, 2012, The demand for, and consequences of formalization among informal firms in Sri Lanka, Impact evaluation, IZA, Bonn, Field experiment in Sri Lanka about formalisation and its consequences.

2.2 DECENT WORK AND ENTERPRISE GROWTH

2.2.2 Formalising work in IE

Recommendation: 10. Design tailor-made strategies for formalisation that are in line with the local context. Take into account all the possible hurdles, implications and reactions of the system. Note that at least one study found that providing information and reimbursing the cost of registration did not induce more firms to register than those who were not provided with reimbursements.

References: De Mel, Suresh; McKenzie, David; Woodruff, Christopher, 2012, The demand for, and consequences of formalization among informal firms in Sri Lanka, Impact evaluation, IZA, Bonn, Field experiment in Sri Lanka about formalisation and its consequences.

Evidence sample: 

A noteworthy experiment was conducted in Sri Lanka, with the goal of generating data to test whether the exclusion or the exit view of informality better reflects reality. The experiment worked with a sample of informal firms with 1 to 14 paid employees: it reduced the information costs and increased the monetary benefits of formalizing for a random subset of the sample. In order to run, the experiment, four treatment groups were shaped. The first treatment group was given information about the costs and benefits of, and procedures for, registering their firm with the Divisional Secretariat (DS) – the relevant registration for tax purposes. Additionally, they were reimbursed for the (modest) direct cost of registration if they registered. The second, third, and fourth treatment groups were provided the same information and also offered a payment to register. Surprisingly, the experiment found that providing information and reimbursing the cost of registration did not induce firms to register. There are several reasons and implications behind a result as such:

1) An important share of the firms not registering after receiving the largest incentive report that issues related to land tenancy prevented them from doing so. These firms operated with informal leases or agreements, and hence were unable to provide authorities with the required proof of ownership of the land on which the firm operated.

2) Firms which formalized are found to have higher profits, although this impact seems largely due to increased advertising and use of receipt books, but no increases in receipt of government contracts, use of bank accounts or loans, or participation in government programs.

3) Data do suggest that given the current tax code, the additional tax collections would not be large among this sample of firms. This, combined with the fact that the spill overs to growth are modest, suggests that near-term gains to the government of increased formality are limited. Finally, despite the pervasive interest of governments around the world in trying to increase the size of their formal sector, the experiment results overall suggest little in the way of pent-up demand to become formal among existing firms.