The labor market effects of payroll taxes in a middle-income country: evidence from Colombia
We use a panel of manufacturing plants from Colombia to analyze how the rise in payroll tax rates over the 1980â€™s and 1990â€™s affected the labor 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 â€œless-than-full-shiftingâ€ 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. Keywords; payroll taxes, shifting, wage rigidity, minimum wages
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