Tax Disincentives to Formal Employment in Latin America

Tax–benefit systems in Latin America have expanded alongside social protection, yet persistently high informality continues to constrain fiscal capacity and redistribution. This paper examines how tax policy changes affect formal employment in Bolivia, Colombia, and Ecuador over three periods (2008–2014/15-2019). The multi-country, multi-period design generates multiple quasi-experiments, enhancing external validity relative to studies focused on single reforms. We measure the implicit tax burden of moving from informal to formal work and estimate behavioral responses using grouped estimations robust to treatment heterogeneity. Higher tax burdens on formalization significantly reduce formal employment, with stronger responses concentrated among low-skilled, often self-employed workers facing high social contributions. Counterfactual simulations show that revenue-neutral reforms combining the removal of contribution floors with higher top taxation may simultaneously raise formalization and income tax progressivity, suggesting that expanding redistribution and limiting efficiency costs need not be in conflict in Latin American labor markets.