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Do Payroll Tax Breaks Stimulate Formality? Evidence from Colombia’s Reform

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  • Adriana Kugler
  • Maurice Kugler
  • Luis Omar Herrera Prada

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 10 minimum wages (MW) and self-employed workers with more than 2 employees experienced a reduction of payroll taxes of 13.5% between 2013 and 2014. We use the Colombian Household Surveys, Social Security records and the Monthly Manufacturing Sample to conduct difference-in-difference analyses of the reform. We find evidence of increased formal employment for the affected groups after the reform using all three datasets. 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 temp employment grew after the reform for those earnings less than 10 MW. The results are greatest for those in smaller firms and those earnings close to the MW.

Suggested Citation

  • Adriana Kugler & Maurice Kugler & Luis Omar Herrera Prada, 2017. "Do Payroll Tax Breaks Stimulate Formality? Evidence from Colombia’s Reform," NBER Working Papers 23308, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:23308
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    References listed on IDEAS

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    1. Nickell, Stephen & Layard, Richard, 1999. "Labor market institutions and economic performance," Handbook of Labor Economics,in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 46, pages 3029-3084 Elsevier.
    2. Bell, Linda A, 1997. "The Impact of Minimum Wages in Mexico and Colombia," Journal of Labor Economics, University of Chicago Press, vol. 15(3), pages 102-135, July.
    3. Gruber, Jonathan, 1997. "The Incidence of Payroll Taxation: Evidence from Chile," Journal of Labor Economics, University of Chicago Press, vol. 15(3), pages 72-101, July.
    4. Adriana Kugler & Maurice Kugler & Juan Saavedra & Luis Omar Herrera Prada, 2015. "Long-term Direct and Spillover Effects of Job Training: Experimental Evidence from Colombia," NBER Working Papers 21607, National Bureau of Economic Research, Inc.
    5. Kugler, Adriana D., 2005. "Wage-shifting effects of severance payments savings accounts in Colombia," Journal of Public Economics, Elsevier, vol. 89(2-3), pages 487-500, February.
    6. repec:adr:anecst:y:1996:i:41-42 is not listed on IDEAS
    7. Maloney, William F, 1999. "Does Informality Imply Segmentation in Urban Labor Markets? Evidence from Sectoral Transitions in Mexico," World Bank Economic Review, World Bank Group, vol. 13(2), pages 275-302, May.
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    More about this item

    JEL classification:

    • 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
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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