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

43 Pages Posted: 10 Apr 2017 Last revised: 10 Mar 2022

See all articles by Adriana D. Kugler

Adriana D. Kugler

McCourt School of Public Policy ; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics; National Bureau of Economic Research (NBER)

Maurice Kugler

IMPAQ International LLC

Luis Omar Herrera Prada

World Bank

Date Written: April 2017

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

Kugler, Adriana Debora and Kugler, Maurice and Herrera Prada, Luis Omar, Do Payroll Tax Breaks Stimulate Formality? Evidence from Colombia's Reform (April 2017). NBER Working Paper No. w23308, Available at SSRN: https://ssrn.com/abstract=2949612

Adriana Debora Kugler (Contact Author)

McCourt School of Public Policy ( email )

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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

IZA Institute of Labor Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Maurice Kugler

IMPAQ International LLC ( email )

1325 G Street, NW
Suite 900
Washington, DC 20005
United States

Luis Omar Herrera Prada

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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