Monetary Incentives to Formality: A Labour Supply Analysis for Colombia

Recent research on informality in Colombia shows that reforms aimed at stimulating the demand for formal employment by reducing corporate taxes have had only modest effects on the relative size of informal employment. Given the apparent limits of demand-side policies and considering that 73 % of informal workers are self-employed this paper examines the incentives that influence the supply of formal labour. Specifically, it quantifies the monetary costs faced by informal work-ers when deciding to become formal. The paper definesthe potential monetary loss associated with formali-sation through the Formalisation Tax Rate (FTR) and calculates it across several simulated scenarios. When the monetary benefits granted by law to formal employ-ees are included (such as family and transport subsidies and mandatory bonuses), some informal employees may have an incentive to formalise. However, self-employed workers—who make up the majority of informal employ-ment—would have no incentive to enter formal work unless their income base were raised to at least the level of the monthly minimum wage.