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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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    File URL: http://eprints.lse.ac.uk/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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    6. Adriana Kugler & Maurice Kugler & Juan Saavedra & Luis Omar Herrera Prada, 2015. "Long-Term Educational Consequences of Vocational Training in Colombia: Impacts on Young Trainees and Their Relatives," NBER Working Papers 21607, National Bureau of Economic Research, Inc.
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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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