3.2 Summary Statistics: Informality Indicators, 2015

TABLE 3.2 Summary Statistics: Informality Indicators, 2015

Indicator Observations Mean Standard deviation Before After Difference

State-year sample Share of formal firms 138 0.065 0.117 0.074 0.058 −0.016 Share of formal output 138 0.710 0.309 0.559 0.838 0.279*** Share of formal labor 138 0.286 0.235 0.259 0.309 0.050* State-industry-year sample Share of formal firms 1614 0.261 0.376 0.232 0.281 0.049*** Share of formal output 1589 0.677 0.336 0.570 0.754 0.184*** Share of formal labor 1598 0.460 0.380 0.415 0.493 0.078***

Source: 2000–15 data of the Annual Survey of industries and the unorganized manufacturing Enterprises Survey. Note: before = before vAT adoption. After = after vAT adoption. vAT = value added tax. *p < .1 **p < .05 ***p < .001.

Following Hoseini and Briand (2020), the firm-level data are first aggregated to twodigit state-industry-year data to increase the identification power. The difference in differences specification is then used to reveal the effect of VAT reform on informality. The model is given by equation 3.1:

ysit = β0 + β1 ⋅ VATst + αsi + τt + εst, (3.1)

where ysit is a measurement of formality—share of formal firms, share of formal sector output, share of workers employed in the formal sector—in state s and year t; VATst is a VAT adoption dummy that equals 1 if state s adopts VAT in year t; and αsi and τt are a state-industry dummy and a year dummy, respectively.

Table 3.3 reports the results. After VAT adoption, the share of formal firms increases by 2.9 percentage points (the extensive margin), and the share of formal sector employment expands by 4.3 percentage points (the intensive margin). The share of formal sector employment also rises by 4 percentage points. This suggests that the VAT benefits incumbent formal firms and expands the production and employment among these firms. Annex 3C provides more robustness checks and empirical results from global experience.

More than 50 countries have adopted a VAT in the past 30 years; some did so with the explicit goal of encouraging formalization. Taking advantage of this natural experience, the analysis next examines the links between VAT adoption and informality in this international experience.

Medina and Schneider (2018) calculate the share of the informal economy across 165 countries in 1991–2017. The analysis here combined this dataset with a dataset on the timing of VAT adoption in 109 countries. The resulting sample includes 109 developing countries, of which 55 countries adopted a VAT from 1991 to 2017.