The aim of this paper is twofold. First, it provides a comprehensive assessment of the financial disincentives to enter formal employment implied by the design of the tax-benefit system in five Latin American countries: Bolivia, Colombia, Ecuador, Peru, and Venezuela. Then, it analyzes the extent to which formalizing informal workers would contribute to increase fiscal capacity in the region. The results show a wide variation in financial disincentives to enter formal employment, with formalization tax rates ranging between 8.5 percent in Venezuela and 42 percent in Colombia. Formalization tax rates are particularly high for self-employed informal workers, and mainly driven by the high costs associated with social insurance contributions. The analysis further shows that potential entries to formal employment would raise tax revenue in all countries, but mainly through the effect of increased social insurance contributions, whereas personal income tax revenue would have a marginal contribution, except in Bolivia and Venezuela. Interestingly, potential formalization of informal workers with the highest probability of being formal would allow capturing a substantial share of the additional tax revenue lost due to informality.
The results presented herein are based on the following three projects: (i) LATINMOD, a project sponsored by the Centro Estratégico Latinoamericano de Geopolítica (CELAG), funded by The Venezuelan Economic and Social Development Bank (BANDES) and with the collaboration of EUROMOD; (ii) ECUAMOD v1.4. ECUAMOD is developed, maintained, and managed by UNU-WIDER in collaboration with the EUROMOD team at the Institute for Social and Economic Research (ISER) the Southern African Social Policy Research Institute (SASPRI), and local partners in selected developing countries (Ethiopia, Ghana, Mozambique, Tanzania, Zambia, Ecuador and Viet Nam) in the scope of the SOUTHMOD project. The local partner for ECUAMOD is the Instituto de Altos Estudios Nacionales (IAEN); and (iii) COLMOD v1.2, a project developed and managed by the Faculty of Economics at Universidad Externado de Colombia. The authors are indebted to the many people who have contributed to the development of LATINMOD, SOUTHMOD, ECUAMOD, and COLMOD, as well as to David Rodriguez for his helpful assistance and comments. The results and their interpretation presented in this publication are solely the authors’ responsibility.
The model for Ecuador, ECUAMOD, has been developed and is maintained as part of the SOUTHMOD project. For more information see Jara and Varela () and https://www.wider.unu.edu/project/southmod-simulating-tax-and-benefit-policies-development . The model for Colombia, COLMOD, is developed and maintained by the Faculty of Economics at Universidad Externado de Colombia. For more information see Rodriguez () and https://www.uexternado.edu.co/economia/colmod-el-primer-modelo-de-microsimulacion-en-colombia/ . The models for Bolivia and Venezuela have been developed as part of the LATINMOD project. LATINMOD is a regional tax-benefit microsimulation model for six Latin American countries (Argentina, Bolivia, Mexico, Paraguay, Uruguay and Venezuela). For more information, see Arancibia et al. () and Oliva (). The model for Peru, PERUMOD, has been developed as part of the project “Simulating Tax Policy Reforms and Fiscal Gains in the Andean Region,” which was funded by the Inter-American Development Bank.
© 2022, The Author(s).