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Do payroll tax breaks stimulate formality? Evidence from Colombia’s reform

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  • Kugler, Adriana D.
  • Kugler, Maurice D.
  • Herrera-Prada, Luis O.

Abstract

Alternative work arrangements have grown rapidly around the world. In Latin America, these alternative work arrangements have long been part of the labor market and have continued to grow. The informal sector grew rapidly in Latin America over the past few decades comprising up to half of the working population in many countries. Some attribute the growth in alternative work arrangements and informality to regulations and taxes, while others argue that it is precisely the lack of enforcement of regulations that allows unprotected employment arrangements to flourish. We examine whether reducing taxes associated with employment stimulates formal sector employment. We exploit the fact that the tax reform introduced in Colombia in 2012 affected only certain types of workers and not others. In particular, workers earning less than ten times the minimum wage and self-employed workers with more than two employees experienced a reduction of payroll taxes of 13.5 percent between 2013 and 2014. We use the Colombian household surveys, social security records and the monthly manufacturing sample to conduct difference-in-differences analyses of the reform. We find evidence of increased formal employment for the affected groups after the reform using all three data sets. We find that the probability of formal employment and the likelihood of transitioning into registered employment increased for the affected groups after the reform. We also find that the level and share of permanent employment relative to temporary employment grew after the reform for those earnings less than ten times the minimum wage. The results are greatest for those in smaller firms and for those earnings close to the minimum wage.

Suggested Citation

  • Kugler, Adriana D. & Kugler, Maurice D. & Herrera-Prada, Luis O., 2017. "Do payroll tax breaks stimulate formality? Evidence from Colombia’s reform," LSE Research Online Documents on Economics 123312, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:123312
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    References listed on IDEAS

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    1. Bosch, Mariano & Goni, Edwin & Maloney, William, 2007. "The determinants of rising informality in Brazil : Evidence from gross worker flows," Policy Research Working Paper Series 4375, The World Bank.
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    4. Adriana Kugler, 1999. "The Impact of Firing Costs on Turnover and Unemployment: Evidence from the Colombian Labour Market Reform," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(3), pages 389-410, August.
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    Cited by:

    1. Guo, Audrey, 2024. "Payroll tax incidence: Evidence from unemployment insurance," Journal of Public Economics, Elsevier, vol. 239(C).
    2. Eduardo Lora, 2021. "Forecasting Formal Employment in Cities," Revista de Economía del Rosario, Universidad del Rosario, vol. 24(1), June.
    3. Duman, Anil, 2024. "The Diversity of Informal Employment: a survey of drivers, outcomes, and policies," OSF Preprints yg3t7_v1, Center for Open Science.
    4. Elizabeth Ruppert Bulmer & Arvo Kuddo & Michael Weber, 2017. "Reducing the Costs and Enhancing the Benefits of Formality," World Bank Publications - Reports 28572, The World Bank Group.
    5. Fernández Mejía, Cristina, 2025. "The Impact of Tax Asymmetries on Labor and Business Informality: The Case of Colombia," Documentos de Trabajo 21323, Universidad del Rosario.
    6. Torm, Nina & Oehme, Marty, 2024. "Social protection and formalization in low- and middle-income countries: A scoping review of the literature," World Development, Elsevier, vol. 181(C).
    7. Samaniego de la Parra, Brenda & Otero-Cortés, Andrea & Fabio Morales, Leonardo, 2024. "The labor market effects of facilitating social security contributions under part-time employment contracts: Evidence from Colombia," Labour Economics, Elsevier, vol. 91(C).
    8. Yashodhan Ghorpade & Camila Franco Restrepo & Luis Eduardo Castellanos, 2024. "Social Protection and Labor Market Policies for the Informally Employed," World Bank Publications - Reports 41328, The World Bank Group.

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    More about this item

    Keywords

    payroll taxes; informality; tax reform; permanent employment;
    All these keywords.

    JEL classification:

    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • J2 - Labor and Demographic Economics - - Demand and Supply of Labor
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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