# **1. Introduction**

Access to credit is a major barrier preventing informal firms from growing. Some argue that reducing the costs of formalization (red tape costs) would help firms to access credit in commercial banks and subsidized credit lines from governmental agencies to support scale and growth. The relationship between access to finance and growth is suggested by anecdotal evidence (de Soto, 1989 and 2000) and, more formally, by theoretical models (see Paula and Scheinkman, 2010 for a reference).

Recently, applied researchers have used experimental and quasi-experimental impact evaluation methods to test the effect of tax simplification policies on formalization rates and performance outcomes of micro, small, and medium-sized enterprises (MSMEs). In a recent survey, Bruhn and McKenzie (2014) summarize the evidence of rigorous impact evaluations; they argue that most informal firms do not seem to formalize and therefore do not benefit from such policies. Fajnzylber et al. (2011) can then be seen as an exception.

Fajnzylber et al. (2011) found large effects of the Brazilian tax simplification program SIMPLES ( _Sistema Integrado de Pagamento de Impostos e Contribuições das Microempresas e Empresas de Pequeno Porte_ ) on formalization rates and performance indicators of firms with up to five employees. They used the change in legislation at the end of 1996 as an event study and used regression discontinuity (RD) design and difference-in-difference (DID) methods to evaluate the impact of the program.

Their main findings show an increase in the formalization rates of about 11 percentage points (or 50 percent) and local average treatment effects on revenues and profits of about 361 and 326 percent, respectively (see table 6 in their paper). They also found an impact on fixed assets and employment. Interestingly, they found no effect on access to credit. This could suggest that formal firms created just after the change in the law were not credit constrained and may have decided to start up as formal for other reasons.

Curiously, the same journal published another evaluation of the same tax simplification program that arrived at different conclusions. Unlike Fajnzylber et al. (2011), Monteiro and Assunção (2012) found a positive and significant impact on formalization rates but only among firms in the retail sector. The authors report no results on firm performance indicators and are, in fact, very skeptical about the impact of SIMPLES on formalization rates and firm performance.

Looking carefully at both studies, a few differences stand out. For instance, Monteiro and Assunção (2012) use firms that are 0-20 months old, while Fajnzylber et al. use firms that are 3-20 months old, with a kernel function with one month bandwidth to assign higher weights to observations close to the threshold (the date the law was passed). Another difference may have to do with the sample composition. Fajnzylber et al. (2011) considered entrepreneurs aged 20-65 without college degrees while Monteiro and Assunção (2012) apparently used the whole sample.

Monteiro and Assunção (2012) used ineligible firms that started business after December 1996 as a counterfactual. In the RD framework, the counterfactual is less clear, as the data do not allow one to distinguish between genuine new entrants and informal firms that decided to formalize with the program. A key difference between these two studies is the date each used for the implementation of the program. Monteiro and Assunção (2012) used December, while Fajnzylber et al. (2011) used November 1996 as 2