Fiscal measures

informality refer to EMDEs with above-median informality, and EMDEs with low informality refer to EMDEs with below-median informality. Second, a local projection model as in Jordà (2005), Teulings and Zubanov (2014), and World Bank (2018a) is estimated to identify the effects of policy changes on informality over time for a sample of up to 125 EMDEs during 1990-2018. The model estimates the cumulative changes in informality after policy changes over different time horizons while controlling for country fixed effects and per capita income levels (table 6B.4).7 Policy changes are defined as a unit change in the corresponding policy indicator. For instance, a 1-percentage-point increase in the personal income tax rate is considered a tax policy change. Annex 6A details the model specification.

High tax rates or payments, complicated tax codes, and administrative burdens have been commonly cited as reasons for informal activity (Auriol and Warlters 2005; Perry et al. 2007; Waseem 2018). Lax tax enforcement facilitates poor tax compliance (Slemrod 2019). Poor government services—often underfunded and inefficiently delivered—will tend to erode tax morale (Awasthi and Engelschalk 2018). In a sweeping survey of the literature, measures to address such issues have been identified as having been particularly effective at encouraging a shift into formal activity (Jessen and Kluve 2021; World Bank 2019b).

Tax rates

Higher tax rates in more informal EMDEs. On average during 2010-2018, average corporate and personal incomes tax rates were significantly higher, by 3 (corporate) to 4 (personal) percentage points in EMDEs with above-median output informality than in those with below-median output informality. Value added tax (VAT) rates were also statistically significantly higher in EMDEs with above-median output informality than in those with below-median output informality.8

Over time, shift away from income taxes. Since 1990, both corporate and personal income tax rates have been lowered in EMDEs whereas the use of VAT has expanded. Average corporate and personal income tax rates in EMDEs have fallen by 13 and 15 percentage points, respectively, from close to 40 percent in the beginning of the 1990s to about 24 percent in 2020 (figure 6.2). About two-thirds of EMDEs lowered their statutory personal income tax rates and more than three-quarters lowered their statutory

7 The results are robust to using self-employment as ameasure of employment informality (table 6B.5). As further robustness checks, both ordinary least squares and quantile regressions are performed using the same set of policy for both output and employment informality measures. The regression results are largely in line with the findings from the group comparison approach (tables 6B.6-6B.7). 8In contrast, EMDEs with high or low informality often do not differ significantly in their average statutory rates for social security contributions nor their revenue collections from such taxes, but they do differ significantly in the amount of social security they provide (see below).