Association for Public Policy Analysis & Management

Informality is the collection of firms, workers, and activities that operate outside the legal and regulatory frameworks and it has been a persistent problem in Latin-America. Around 2000, 55% of all workers were employed in low productivity firms and 50% made no pension contributions. By 2014 the corresponding figures were 50% and 46%, just 5 and 4 percent points decrease in 14 years. One of the main causes for informality are related to high taxes. Studies find for Latin-America that value added taxes may increase informality, corporate income taxes may help reduce informality, especially among low education workers, and the effect of payroll taxes depends crucially on how workers value their contributions. Studies for Colombia point to high payroll taxes as one of the main causes of informality. In line with this, the Colombian government passed the Tax reform of 2012 which substantially reduced firms’ payroll taxes and increased Corporate Income Taxes (CIT) to promote formal employment. Despite its relevance, current studies provide just partial evidence of its effects, using just Ordinary Least Squares or general equilibrium models calibrated with data before the Tax reform. Other studies study the relation between Non-Wage Costs (NWC) and informality but none covers the period after the Tax reform.

I use household and firms’ surveys microdata, from before and after the reform, to obtain Difference-in-Difference (DiD) estimates. Based on household survey data I estimate the effect of the reform on the probability that a worker will be informal. With firms’ survey microdata, I evaluate how the tax reform changed the percent of workers’ firms choose to keep in informality. For both sources, I classify workers and firms in control and treatment groups exploiting sectors excluded from the Tax reform.

Current results indicate that, despite the decrease in informality in the period of analysis, the Tax reform had a small to non-significant impact. At workers’ level, all estimates indicate about 2 percent decrease in the probability of becoming informal, but just for certain quarters and in others estimates are positive. For firms, I also obtain at most a 1 percent decrease in the percent of informal workers in 2014 but this was completely reversed in 2015, where estimates indicate 3 to 5 percent increase (probably related with the oil prices shock). Lastly, I can compare results across both sources of data and I obtain non-significant estimates on workers and slightly significant estimates for firms in 2013 and 2014.