Abstract
Using a panel of administrative data and regression discontinuity analysis, this paper examines how the introduction of preferential tax regimes for Georgian micro- and small businesses in 2010 affected formal firm creation and tax compliance. The results show that the new tax regime for micro-businesses increased the number of newly registered firms by 27–41 % below the eligibility threshold during the first year of the reform, but not in subsequent years. We do not find an effect of the new tax regime for small businesses on formal firm creation in any year. Policy makers are often also concerned about abuse risks stemming from differentiated tax treatment of micro- and small businesses. The analysis in this paper reveals reduced tax compliance among small taxpayers for multiple years after the reform and among micro-business taxpayers only during the first year of the reform.
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Notes
When looking at the loosely defined concept of informality from a tax policy vantage point, the need for nuance becomes obvious (Keen 2013). Broadly speaking, while small and unregistered businesses have little to do with large tax evaders, unreported business activity is “informal” regardless of its initiator. Perry et al. (2007) provide an overview of the range of agents that can be captured under the term informality. In the context of this paper, a definition of “firms and individuals avoiding taxation or other mandated regulations (...) [or] registering only part of their workers and part of their sales” (Perry et al. 2007, pp. 21–22) seems most appropriate.
Using the August 2012 exchange rate of \(1\ \hbox {GEL} = 0.6085\hbox { USD}\).
In a related paper, Slonimczyk (2012) studies the effects of a Russian tax reform, which reduced average tax rates for the personal income tax and the payroll or social tax, on informal employment. He finds that the tax reform led to a significant reduction in the fraction of informal employees and in the prevalence of informal irregular activities.
The Pakistani income tax system has different brackets with constant average rates.
See discussion on Georgia in Engelschalk (2004).
Retail trade, goods production, services, transportation, jewelry shops, repair of watches, as well as an indicator based tax regime for restaurants.
Presumptive tax collection was only GEL 5 million or 0.7 % of total tax revenue in 2000 (see Engelschalk 2004).
It is, however, unlikely that the changes in perception were solely driven by the (re-)introduction of a simplified presumptive tax regime given that many respondents to the survey have likely not registered for the regime (see Table 4 below). A number of additional reforms aimed at improving taxpayer experiences were adopted in 2010, including, for instance, a revised tax appeals process.
See for example: Georgian Journal, September 23, 2010: “New Tax Code Favors Small Business”; Finchannel September 21st: “IFC, Georgian Ministry of Finance Host Public-Private Dialogue to Reform Tax System; 24 h (Daily Georgian Newspaper), 17th September: “Consultation on New Tax Code Finished”.
This approach is based on the assumption that taxpayers, who are required and capable to comply with the standard VAT, can also be expected to pay taxes based on their income.
The regime provides a number of key advantages over a system simply based on gross turnover, most importantly by providing an incentive for performing basic accounting and maintaining a single rate while recognizing differences in sector profitability. At the same time, the approach favors businesses with high-profit margins (for instance in the service sector).
Although the reform implies that micro-businesses do not have to pay income tax, they still have to file a tax return post-reform and we thus have data on their declared revenue for both the pre- and post-reform period. Also, even though small businesses may be taxed based on turnover vs. income after the reform, they have to declare revenue on their tax return in either case, so that we have data on their declared revenue pre- and post-reform.
Companies tend to have much higher revenues than sole proprietors and are thus likely not a valid comparison group for firms that are eligible for the reform. The average (median) revenue for companies in the database is about GEL 1 million (GEL 67,000) compared to GEL 38,000 (GEL 9700) for sole proprietors.
The database includes information on number of employees only for a small subset of firms.
We chose this interval size to obtain a reasonably large number of intervals for the analysis while including a sizeable number of firms in each interval. Our findings are robust to using intervals of size GEL 50 or GEL 200 instead.
We chose this interval size to obtain a reasonably large number of intervals for the analysis while including a sizeable number of firms in each interval. Our findings are robust to using intervals of size GEL 250 or GEL 1000.
It is important to note that these numbers are smaller than the overall fractions of eligible firms that registered for each regime reported in Table 1. A limitation of the RDD approach is that it estimates the effect of the reform only for firms close to the cutoff. The effect may be different for firms further below the cutoff. However, we do not have a valid counterfactual for these firms since they are likely to be quite different from firms above the cutoff.
The average number of new firms registered in the 10 revenue intervals above the GEL 30,000 cutoff was 8.3 in 2011. That is, an increase in the number of firms by 2.256 corresponds to 2.256/8.3 = 37 % (similarly for 3.42).
However, differences in observed magnitudes need to be interpreted with caution. Arguably, our estimate based on a difference-in-differences approach at the GEL 100,000 threshold is less precise than the pure discontinuity design used for the GEL 30,000 threshold.
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Acknowledgments
We thank Vazha Nadareishvili, Ekaterine Avaliani, Peter Barrand, Jacqueline Coolidge, Michael Engelschalk, Martin Grote, DavidMcKenzie, Michael Keen, and members of the impact evaluation and business taxation teams in the World Bank’s Trade and Competitiveness practice, as well as participants of the DIBT research seminar at the Vienna University of Economics and Business for their helpful inputs and comments. We would also like to thank the Georgian Revenue Service and Ministry of Finance as well as the Investment Climate Impact Project for guidance and support. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors and should not be attributed to the World Bank, its Executive Directors, or the countries which they represent. All remaining errors and inaccuracies are, of course, our own.
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Bruhn, M., Loeprick, J. Small business tax policy and informality: evidence from Georgia. Int Tax Public Finance 23, 834–853 (2016). https://doi.org/10.1007/s10797-015-9385-9
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DOI: https://doi.org/10.1007/s10797-015-9385-9