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Financing Social Expenditures in Developing Countries: Payroll or Value Added Taxes?

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  • Richard M. Bird

    ()
    (University of Toronto)

  • Michael Smart

    (University of Toronto)

Abstract

At present most social protection programs in Latin American countries are financed by payroll taxes levied on the formal sector. Increasingly, some countries are both extending some benefits similar to those received from these programs to non-contributors and financing such extensions as well as some benefits for contributors from general revenues, which at the margin in most countries means from the value added tax. In this paper we consider the efficiency of payroll taxes compared to value-added taxes as a way of financing expanded social programs in countries with large informal sectors. To do so, we construct a simple formal model that indicates, in general, that a revenue-neutral move from payroll to value-added taxes will reduce informality and increase wages, output and welfare. While the issue is not a simple one, and the specific conditions in each country need careful consideration, this analysis suggests that in countries with large informal sectors it is probably best to finance incremental expansions of social programs from broad-based taxes like VAT instead of payroll taxes.

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Bibliographic Info

Paper provided by International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University in its series International Center for Public Policy Working Paper Series, at AYSPS, GSU with number paper1206.

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Length: 39 pages
Date of creation: 13 Jan 2012
Date of revision:
Handle: RePEc:ays:ispwps:paper1206

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  1. Chang-Tai Hsieh & Peter Klenow, 2009. "Misallocation and Manufacturing TFP in China and India," Working Papers 09-04, Center for Economic Studies, U.S. Census Bureau.
  2. Adriana Camacho & Emily Conover, 2010. "Misallocation and Productivity in Colombia's Manufacturing Industries," IDB Publications 6783, Inter-American Development Bank.
  3. Aureo de Paula & Jose A. Scheinkman, 2009. "“Value Added Taxes, Chain Effects and Informality”, Second Version," PIER Working Paper Archive 09-041, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 09 Nov 2009.
  4. Alberto Barreix & Jerónimo Roca & Luiz Villela, 2007. "Fiscal policy and equity estimation of the progressivity and redistributive capacity of taxes and social public expenditure in the Andean countries," INTAL Working Papers 1466, Inter-American Development Bank, INTAL.
  5. Andrew Feltenstein & Maral Shamloo, 2013. "Tax reform, the informal economy, and bank financing of capital formation," International Tax and Public Finance, Springer, vol. 20(1), pages 1-28, February.
  6. Keen, Michael, 2008. "VAT, tariffs, and withholding: Border taxes and informality in developing countries," Journal of Public Economics, Elsevier, vol. 92(10-11), pages 1892-1906, October.
  7. Richard M. Bird & Michael Smart, 2008. "The Economic Incidence of Replacing a Retail Sales Tax by a Value-Added Tax: Evidence from Canadian Experience," Working Papers Series 14, Rotman Institute for International Business, Joseph L. Rotman School of Management, University of Toronto, revised Jun 2008.
  8. Aureo de Paula & Jose A. Scheinkman, 2007. "The Informal Sector, Third Version," PIER Working Paper Archive 08-018, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 21 May 2008.
  9. Keen, Michael & Lockwood, Ben, 2007. "The Value Added Tax : Its Causes and Consequences," The Warwick Economics Research Paper Series (TWERPS) 801, University of Warwick, Department of Economics.
  10. Robin Boadway & Motohiro Sato, 2009. "Optimal Tax Design and Enforcement with an Informal Sector," American Economic Journal: Economic Policy, American Economic Association, vol. 1(1), pages 1-27, February.
  11. Olivier Cardi & Romain Restout, 2010. "Sectoral Effects of Tax Reforms in an Open Economy," Working Papers hal-00544475, HAL.
  12. Richard M. Bird & Eric M. Zolt, 2014. "Redistribution via Taxation: The Limited Role of the Personal Income Tax in Developing Countries," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 625-683, November.
  13. Guillermo Cruces & Sebastian Galiani & Susana Kidyba, 2010. "Payroll Taxes, Wages and Employment: Identification through Policy Changes," CEDLAS, Working Papers 0093, CEDLAS, Universidad Nacional de La Plata.
  14. Arias-Vazquez, Francisco Javier & Azuara, Oliver & Bernal, Pedro & Heckman, James J. & Villarreal, Cajeme, 2010. "Policies to Promote Growth and Economic Efficiency in Mexico," IZA Discussion Papers 4740, Institute for the Study of Labor (IZA).
  15. Adriana Kugler & Maurice Kugler, 2009. "Labor Market Effects of Payroll Taxes in Developing Countries: Evidence from Colombia," Economic Development and Cultural Change, University of Chicago Press, vol. 57(2), pages 335-358, 01.
  16. M. Shahe Emran & Joseph E. Stiglitz, 2002. "On Selective Indirect Tax Reform in Developing Countries," International Trade 0210003, EconWPA.
  17. Guillermo E. Perry & William F. Maloney & Omar S. Arias & Pablo Fajnzylber & Andrew D. Mason & Jaime Saavedra-Chanduvi, 2007. "Informality : Exit and Exclusion," World Bank Publications, The World Bank, number 6730, October.
  18. Thomas Dalsgaard, 2008. "Tax and Welfare Reforms in the Czech Republic," IMF Working Papers 08/52, International Monetary Fund.
  19. Bird,Richard & Gendron,Pierre-Pascal, 2007. "The VAT in Developing and Transitional Countries," Cambridge Books, Cambridge University Press, number 9780521877657, October.
  20. Guillermo Javier Vuletin, 2008. "Measuring the Informal Economy in Latin America and the Caribbean," IMF Working Papers 08/102, International Monetary Fund.
  21. José A. Pagán & Gökçe Soydemir & José A. Tijerina-Guajardo, 2001. "The Evolution Of Vat Rates And Government Tax Revenue In Mexico," Contemporary Economic Policy, Western Economic Association International, vol. 19(4), pages 424-433, October.
  22. Robert Holzmann & David A. Robalino & Noriyuki Takayama, 2009. "Closing the Coverage Gap : The Role of Social Pensions and Other Retirement Income Transfers," World Bank Publications, The World Bank, number 2651, October.
  23. Ferreira , Francisco H.G. & Robalino, David, 2010. "Social protection in Latin America : achievements and limitations," Policy Research Working Paper Series 5305, The World Bank.
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