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The Labour Market Effects of Payroll Taxes in a Middle-Income Country: Evidence from Colombia

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  • Kugler, Adriana D.
  • Kugler, Maurice

Abstract

We use a panel of manufacturing plants from Colombia to analyse how the rise in payroll tax rates over the 1980s and 1990s affected the labour market. Our estimates indicate that formal wages fall by between 1.4% and 2.3% as a result of a 10% rise in payroll taxes. This ‘less-than-full-shifting’ is likely to be the result of weak linkages between benefits and taxes and the presence of downward wage rigidities induced by a binding minimum wage in Colombia. Because the costs of taxation are only partly shifted from employers to employees, employment should also fall. Our results indicate that a 10% increase in payroll taxes lowered formal employment by between 4% and 5%. In addition, we find less shifting and larger disemployment effects for production than non-production workers. These results suggest that policies aimed at boosting the relative demand of low-skill workers by reducing social security taxes on those with low earnings may be effective in a country like Colombia, especially if tax cuts are targeted to indirect benefits.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4046.

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Date of creation: Sep 2003
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Handle: RePEc:cpr:ceprdp:4046

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Keywords: minimum wages; payroll taxes; shifting; wage rigidity;

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  1. Holmlund, Bertil, 1983. "Payroll Taxes and Wage Inflation: The Swedish Experiences," Working Paper Series, Research Institute of Industrial Economics 68, Research Institute of Industrial Economics.
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  7. Kugler, Adriana & Jimeno, Juan F. & Hernanz, Virginia, 2002. "Employment Consequences of Restrictive Permanent Contracts: Evidence from Spanish Labor Market Reforms," IZA Discussion Papers 657, Institute for the Study of Labor (IZA).
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  15. Kevin Lang, 2004. "The Effect of the Payroll Tax on Earnings: A Test of Competing Models of Wage Determination," Econometric Society 2004 North American Winter Meetings 360, Econometric Society.
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