The journey to formality: How credit market access shapes informal workers' choices

Abstract

We analyze how credit market accessibility affects the transition of informal workers to the formal sector in Russia. Formal lenders determine credit limits based on verified income and incentivize informal workers to formalize their income in order to qualify for a loan. Better credit accessibility increases the likelihood of transitioning from informal to formal work. It also decreases tax evasion and raises the share of income being declared for tax purposes. Findings are robust across different model specifications, including dynamic multinomial logit model and event study approach. Simulated interventions suggest that more bank competition and a shorter distance to banks reduce the size of the informal sector and increase the tax-declared share of income.