Payroll Taxes, Social Security and Informality. The 2012 Tax Reform in Colombia

I evaluate how the drastic reduction in payroll taxes in 2012 reduced informality in Colombia. By the end of 2012 the Colombian government implemented a tax reform that, among other things, substantially reduced payroll taxes. I evaluate the effect of this reform on informality both theoretically and empirically. Theoretically, I develop a labor market model incorporating the changes introduced by the reform. As the reduction in payroll taxes was accompanied by a change in social trans-fers' funding, which led to uncertain changes in profits and social benefits, straightforward predictions on informality are not possible. Empirically, I obtain difference-in-difference (DID) estimates from two household surveys- one composed by many repeated cross sections across many years and the other a much shorter panel dataset. Estimates from the repeated cross sections data indicate small, short-term effects and large long-term effects. Industry was the first sector to enjoy a reduction in informality, followed by services and agriculture. For workers earning around one minimum wage, I find large point estimates. Estimates from the household survey panel data are in line with these results.