
Bargain, Olivier, Jara, H. Xavier and Rivera, David (2024) Tax disincentives to formal employment in Latin America. III Working Paper (144). International Inequalities Institute, London School of Economics and Political Science, London, UK.
To finance increased public spending and social programs, Latin America’s tax systems need
to develop further. Yet taxation can reduce the tax base by discouraging formal employment.
Evidence on the intensity of the problem is limited and tends to focus on specifically large
reforms of the tax system. Conversely, and to improve external validity, we study whether
routine changes in tax policies also alter labor market formalization. Our approach is based on
grouped-data estimations of formal employment responses to policy changes. We exploit tax
variation across three countries (Bolivia, Ecuador and Colombia) and three periods (2008,
2014/15, 2019). We use precise calculations of counterfactual tax burdens when moving from
informal to formal jobs, i.e. formalization tax rates (FTRs). For most countries and pairs of
years, FTRs have a negative and significant effect on formal employment, particularly when
wages are held constant across periods – in order to extract the pure policy effect – and in a
series of sensitivity checks.