Academic journal article Economia

Switching from Payroll Taxes to Corporate Income Taxes: Firms’ Employment and Wages after the 2012 Colombian Tax Reform

Academic journal article Economia

Switching from Payroll Taxes to Corporate Income Taxes: Firms’ Employment and Wages after the 2012 Colombian Tax Reform

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Social security systems aimed at covering workers against the risks of old-age poverty, sickness, work-related accidents, and unemployment are frequently financed via mandatory payroll contributions paid by both employers and employees, with employers usually responsible for the larger share of the contribution.1 In much of Latin America, high payroll taxes have been pinpointed as one of the causes of high informality and high unemployment.2

In Colombia, payroll taxes have been used to finance not only health coverage, maternity leave provisions, and pensions, but also monetary subsidies and in-kind transfers for low-income workers.3 Employers are also responsible for mandatory bonuses and annual severance payments. Put together, these costs imposed by regulation added more than 50 percent to a firm's wage bill by 2012. This rate had been increasing over the last two decades from an already high 40 percent in 1992. Costs attached to these regulations come on top of a mandatory minimum wage that exceeds the median income of workers in the country.

Extremely high payroll taxation in Colombia is a source of concern for analysts and policymakers, given its expected negative effects on employment and labor formality. Both unemployment and informality have, in fact, been very high over the past two decades. Consequently, the Colombian Congress approved a tax reform in December 2012 that reduced employer contributions by 13.5 percentage points for workers earning below ten minimum monthly wages. This group of workers represents the vast majority of the Colombian workforce (specifically, 98 percent of workers of private firms with at least two employees). In particular, the reform eliminated a 3 percent contribution to the National Family Welfare Agency (ICBF), a 2 percent contribution to the National Adult Training Agency (SENA), and 8.5 percent of the employers' contributions for workers' mandatory health insurance.

One of the objectives of the reform was to stimulate the creation of formal employment. To compensate for lost income from payroll taxes, the reform also increased corporate income taxes by reducing some of the exemptions that firms were previously allowed to claim to reduce their taxable income. In particular, the corporate income tax rate fell by 8 percentage points, while a new 9 percent tax on firm profits, called CREE, was imposed. The tax base over which firms pay CREE, however, is larger than the base for the corporate income tax, because exemptions were eliminated. Thus, more than a reform that reduced the tax burden, this was a reform that shifted the burden from formal employment to corporate income. The amount of benefits received by workers was not affected by the reform.

This reform offers a unique opportunity to analyze the effectiveness of replacing payroll taxes with taxes that do not distort the incentives to hire workers relative to other inputs of production, but that are still levied on firms. With this motivation, we analyze the effects that the reform had on formal employment and wages, using detailed firm-level administrative data covering all formal employment in the country before and after the reform.

The focus on firms is natural, to the extent that it is firms' hiring and wage policies that are directly distorted by payroll taxes. At the same time, identifying the effects of this reform on firms is particularly challenging, since the reform did not focus on particular firms or sectors. We take advantage of the fact that not-for-profit firms, many of which are de facto for profit, were exempted from the components of the reform under analysis. Though we do not have information on firms' individual tax regimes, we do know the sector to which a firm belongs. Because firms in the education and training sector are with few exceptions registered as not-for-profit, we are able to use these firms to construct a control group. …

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