Panel Paper: Do Payroll Tax Breaks Stimulate Formality: Evidence from Colombia's Reform

Thursday, November 2, 2017
New Orleans (Hyatt Regency Chicago)

*Names in bold indicate Presenter

Adriana Kugler, Georgetown University, Maurice Kugler, IMPAQ International, LLC and Luis O. Herrera Prada, The World Bank

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 differencein-
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.