small business tax policy measures, Onji (2009) documents that generous treatment in the Japanese VAT system provides an incentive for downward migration of larger entities hiding below the eligibility threshold. Kleven and Waseem (2013) provide insights into taxpayer responses to thresholds in a developing country context. Studying the behavioral response to income taxation in Pakistan with administrative data, they find evidence of bunching below bracket cutoffs with discontinuous jumps in tax liabilities.<sup>6</sup> Exploiting tax policy changes in Georgia, we aim to provide further insights into MSE compliance behavior, including an analysis of strategic business behavior that could potentially undermine the objective of policy reform. Using administrative data and a regression discontinuity design, we focus our analysis on the eligibility thresholds for the new regime. We investigate (i.) to which extent the Georgian reforms promote formal firm creation, by prompting more businesses to register with the tax authority, and (ii.) to which extent the reforms impact tax compliance, by providing an incentive to declare a lower fraction of business income to the tax authority, and/or cause firms to hide and migrate below the threshold of eligibility.<sup>7</sup> Our findings suggest that the Georgian reform did indeed contribute to formal firm creation – the new tax regime aimed at micro businesses increased the number of newly registered formal firms below the eligibility threshold of GEL 30,000 by 18-30%. This effect is, however, limited to the first year of the introduction of the reform. Unlike for the micro business regime, we do not find a robust effect of the small business tax regime on formal firm creation in any year. When looking at abuse risks, our results show no significant evidence of strategic sorting following the introduction of the new regime, but we do find some evidence of less tax compliance by previously registered firms around the micro taxpayer threshold. Similarly to the effect on firm registration, this effect on tax compliance appears to be short-lived and only lasts for the first year after the new regime was introduced.

The findings and the underlying analytical steps, including a review of overall taxpayer registration trends are valuable for practitioners - hopefully informing implementation work in Georgia - as well as for the global policy discussion on taxation and informality. While our findings indicate that the design of presumptive tax regimes may indeed be an instrumental policy tool to encourage tax registration, the goal of the Georgian policy reforms, it also suggests that such reforms are, at best, a small piece in a much bigger puzzle. Skepticism about easy solutions in this particular area of tax policy thus seems vindicated. At the same time, the absence of strong evidence of major abuses is meaningful for the discussion of presumptive tax instruments. Similar to the discussion of expected benefits, risks

> 6 The Pakistani income tax system has different brackets with constant average rates.

> 7 The first question above encompasses both the start-up of new formal firms, as well as the tax registration of previously informal firms. Note that the second question allows for the possibility that the reform could decourage firms from declaring a higher fraction of their income. The reason for this possible outcome is that only firms below GEL 30,000/ GEL 100,000 are eligible for the new tax regimes, which could provide an incentive for firms to not report income higher than these amounts. There is also a risk of firms responding to the incentives provided in the simplified regimes by splitting-up activities to reregister them below the threshold(s), thereby increasing new registration levels below the thresholds and decreasing the number of firms above the thresholds. These strategic incentives also pose some difficulties for our empirical analysis, as explained below.

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