Why do Firms Operate Informally? Insights from a Systematic Literature Review/¿POR QUÉ LAS EMPRESAS OPERAN EN LA INFORMALIDAD? REFLEXIONES DE UNA REVISIÓN SISTEMÁTICA DE LA LITERATURA/POR QUE AS EMPREZSAS OPERAM INFORMALMENTE? DESCOBERTAS A PARTIR DE UMA REVISÃO SISTEMÁTICA DA LITERATURA/POURQUOI LES ENTREPRISES OPÈRENT-ELLES DE MANIÈRE INFORMELLE ? APERÇUS D'UNE REVUE SYSTÉMATIQUE DE LA LITTÉRATURE.
| Autor | Pedroni, Florencia Veronica |
| Cargo | Gesti |
Introduction
Unofficial economic activities--those conducted by unregistered or registered firms but hidden from taxation--in many emerging countries account for between a third and a half of total economic activities. This share declines sharply as the economy develops (La-Porta & Shleifer, 2008). Throughout the world, two-thirds of all enterprises are unregistered at their start-up (Autio & Fu, 2015) and over half of all current enterprises operate unregistered (Acs et al., 2013).
The informal economy produces several consequences, making it a relevant issue (Putnin & Sauka, 2015). In the macroeconomic sphere, the informal sector can create a vicious circle: individuals or companies go underground to evade taxes and social security contributions, eroding tax bases and reducing tax revenue. This results in a decrease in the quality and quantity of public goods and available services that encourages increases in tax rates on the formal sector, with the consequent generation of greater incentives to participate in the informal economy. Second, unreported activities can hamper economic growth by diverting resources from productive uses to unproductive ones. In addition, the informal economy distorts official statistics, hindering the task of public-policy makers (Putnin & Sauka, 2015; Schneider & Enste, 2000).
At the microeconomic level, although hidden activities generate additional revenue for companies, various disadvantages arise from this issue. The existence of non-reported sales restricts the ability of firms to obtain debt or capital financing since potential creditors or investors cannot verify real (hidden) cash flows, thus hindering the entity's management process and causing difficulties in results determination (reported and non-reported information is required). It also causes inconveniences in inventory management and loss of control over resources, in general, facilitating potential theft and fraud (Putnin & Sauka, 2015).
Considering the above, this article focuses on firm informality, that is, businesses that are not registered and formal companies that report a lower level of revenue to reduce their tax burden (La-Porta & Shleifer, 2008). In particular, this paper seeks to identify the factors that motivate entrepreneurs or companies to operate totally within informality, as well as the drivers behind revenue underreporting among formal companies. Within the firm informality idea, corporate tax evasion is included, since many formally registered firms evade taxes by underreporting their revenues, which implies partial compliance with tax regulations (Slemrod & Weber, 2012; Ulyssea, 2020). Hence, this article does not study informality in the labor market. In sum, in this work we use the words "informality," "informal economy," and "informal sector" as alternative expressions to refer to the broad definition of the phenomenon; (1) we also use firm/business/corporate informality as synonyms in reference to the narrow concept, which is the object of analysis of the article.
In order to identify firm informality determinants we rely on a systematic review of the theoretical and empirical literature available in Scopus and Web of Science databases, following the review protocol described in the appendix section. Considering that firm informality can be addressed both in informal economy analysis and in tax evasion research studies, we decided to perform a two-stage review to cover both possibilities. After reading the title and abstract of all the articles obtained from the first step of the process, we selected for an in-depth analysis those that were consistent with the object of study (firm informality), the most relevant (number of citations), and the most recent contributions.
Our work presents several contributions. First, the article studies the theoretical pillars linked to informality, including different approaches (structuralist, legalistic) and issues about various theories, as institutional and rational choice, as well as psychological and sociological aspects. Second, unlike previous studies that make a general approach to the informal economy, this paper focuses exclusively on the determinants of business informality. In this way, it emphasizes the study of the reasons that encourage corporate tax evasion--over personal tax evasion (Torgler, 2002)-and explicitly excludes the analysis of unregistered work (labor market informality) causes. Specifically, the article outlines the determinants of business informality by summarizing an important set of studies with different methodological approaches (macro and microeconomic) in different contexts (developed, emerging and transition economies) and periods (1983-2018). Finally, the study proposes an integrative model of business informality determinants, organizing them in groups and theoretical constructs.
Besides this introductory section, the remainder of the article is organized as follows. The next section exposes frameworks of analysis, theoretical basis, and conceptual models that support the hidden activity phenomenon. Afterwards, we will present the empirical background by classifying previous studies according to their methodological approach and describing firm informality determinants and their link with informality, according to the empirical evidence addressed. Encompassing theoretical and empirical points, the section that follows proposes an integral theoretical model of firm informality determinants. The last section concludes by discussing the academic and practical contributions of this work.
Informality: Theoretical framework
Framework of analysis and theoretical basis
The informal sector can be analyzed from two frameworks that can be seen as complementary. On the one hand, the structuralist (2) dimension (Jiménez-Restrepo, 2012), exclusion perspective (Perry et al., 2007) or survival view (La-Porta and Shleifer 2008, 2014), proposes that individuals and companies cannot formally operate because they are too unproductive to ever become formal, even without entry costs. These are small productive units that operate under the motivation of subsistence and the supply of low-quality jobs, in which labor-intensive and low-wage production techniques are abundant. These are entrepreneurs with low human capital, who are only able to survive in the informal sector because they avoid taxes and regulations (Harris & Todaro, 1970; Lewis, 1954; Rauch, 1991). According to this first dimension, the economic and productive structure of a country and the survival instinct of people are what determine the existence of the informal sector.
On the other hand, for the legalistic (3) dimension (Jiménez-Restrepo, 2012), or exit perspective (Perry et al., 2007), the informal sector is shaped by firms and persons that voluntarily decide to operate under the umbrella of informality as a result of a cost-benefit analysis (rational choice). Unregistered firms included in this approach can be classified through the Parasite view or De Soto's view (La-Porta & Shleifer 2008, 2014). The first case involves firms that are productive enough to enter the formal sector but choose not to do so because it is more profitable to operate in the informal sector (Farrell, 2004). De Soto's view corresponds to potentially productive informal companies that operate informally because of high entry costs. If these were removed, companies would enter the formal sector and improve their performance, since they would no longer have size constraints imposed by informality (De-Soto et al., 1987).
Several authors recognize the importance of analyzing the informal sector through the use of mixed models (Jiménez-Restrepo, 2012; Ordóñez-Castaño & Sanabria-Domínguez, 2014; Ortiz & Uribe, 2004) or holistic approaches (Bertranou & Casanova, 2014; Ludmer, 2019).
Sometimes, the informal economy is empirically studied using a single theoretical argument, for example, ideas from the neoclassical stream or institutional theory, or with assertion from some disciplines of the social sciences (sociology, psychology). The neoclassical theory establishes utility maximization based on objective probabilities, institutionalists examine the role of norms, sociologists emphasize the importance of demographic factors, and psychologists consider the intrinsic motivations of agents (Schneider & Enste, 2013). However, in stark contrast to traditional debates that adopt one or another theoretical perspective, recent research emphasizes the need for a comprehensive vision of the conceptual framework to fully understand the prevalence of the informal sector (Williams & Liu, 2019). Figure 1 presents a summary of the relation among the different theoretical and empirical approaches on the subject. The subsections below present different theories that have been used to explain the existence of informal sector: economics, institutional theory, sociology, and psychology.
Economic foundations
From a classic economic perspective, individuals are rational agents (homo economicus) who weigh the costs and benefits when they consider breaking the law. In that sense, their decision to participate partially or completely in the informal economy is a choice under uncertainty. This implies a compensation between the benefits of operating in the informal sector if their activities are not discovered, and the inherent losses if they are detected and penalized (Allingham & Sandmo, 1972; Schneider, 2016). If it is assumed that the behavior of economic agents fits the Von Neumann-Morgenstern axioms under uncertainty, they select their level of income to report at the point that they maximize the expected utility function (Arrow, 1965, 1971; Pratt, 1964; Von-Neumann & Morgenstern, 1944). This expected utility is calculated considering factors such as tax burden, regulations, fines and the probability of detection, among others (Schneider & Enste, 2013).
In this sense, individuals or entrepreneurs...
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