Informality in Latin America: Taxes and beyond III CAF-Oxford Conference Understanding the Challenges of Informality in Latin America St Antony’s College, University of Oxford - Nov 4, 2016

1. Informality in Latin America:
Taxes and beyond
Angel Melguizo
Latin American Unit, OECD Development Centre
III CAF-Oxford Conference Understanding the
Challenges of Informality in Latin America
St Antony’s College, University of Oxford - Nov 4, 2016

2. Did informality decrease during the
commodity boom? – Yes, but not enough
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
BOL
NIC
PER
HON
PRY
GUA
SLV
MEX
COL
DOM
VEN
ECU
ARG
PAN
BRA
CRI
CHL
URY
Formality in LAC (% contributors/workers)
2006
2014
Source: Mejia, C. and A. Melguizo (2016), “La reforma de las pensiones en América Latina: acuerdos de partida,
principios, instrumentos e indicadores”. In Carranza, Melguizo and Tuesta (eds.), Ideas para reforma de
pensiones. Forthcoming.

3. Lauenburg, 1890

4. Macondo
Por Hernando Nossa

5. • Informal is normal in Latin America
• Latin American hour: Productivity, inclusion and
governance
• Taxes and informality: in it together?
• Beyond taxes: a way forward
Informality in Latin America: Taxes and
beyond

6. • Informal is normal in Latin America
• Latin American hour: Productivity, inclusion and
governance
• Taxes and informality: in it together?
• Beyond taxes: a way forward
Informality in Latin America: Taxes and
beyond

7. Informal is normal in Latin America…

8. … for non-wage earners, workers in
small firms, or low-income workers …

9. … and the emerging middle class
43
23
34
39
21
35
15
20
25
30
35
40
45
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Poor (under $4) Vulnerable ($4-$10) Middle class ($10-$50)
Source: World Bank Equity Lab.
LAC population distribution by per capita income level

10. … and the emerging middle class
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
URY CRI BRA MEX COL PER BOL SLV GTM
Vulnerables (4-10 USD/dia) Clase media (10-50 USD/dia)
Informality among the emerging middle class
(% of households without a contributor to pensions/health)
Source: Lustig, N. and A. Melguizo (2015), “How middle class are middle-income households in Latin America?”. VoxLACEA, 2015.

11. • Informal is normal in Latin America
• Latin American hour: Productivity, inclusion
and governance
• Taxes and informality: in it together?
• Beyond taxes: a way forward
Informality in Latin America: Taxes and
beyond

12. Productivity challenge: LAC in the
middle-income trap
1800
2800
3800
4800
5800
6800
7800
8800
9800
10800
11800
GDPpercapitaconstant1990PPPdollars
Ireland Israel Poland Singapore Spain Portugal
Greece Malaysia South Korea China LAC avg
HIGH
MIDDLE
LOW
(GDP per capita constant 1990 PPP dollars)
Source: OECD Development Centre, Avoiding the middle-income trap in Latin America.

13. Inclusion challenge: middle-class
vulnerability is transmitted to the youth
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
15 16 17 18 19 20 21 22 23 24 25 26 27 28 29
Extreme poor
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
15 16 17 18 19 20 21 22 23 24 25 26 27 28 29
Moderate poor
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
15 16 17 18 19 20 21 22 23 24 25 26 27 28 29
Vulnerable
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
15 16 17 18 19 20 21 22 23 24 25 26 27 28 29
Middle class
NEET Informal StudentFormal
Source: OECD/ECLAC/CAF (2016), Latin American Economic Outlook 2017

14. Governance challenge: informality
impacts trusts in politics/policies
Source: OECD/ECLAC/CAF (2016), Latin American Economic Outlook 2017
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
%
Youth (15-29) Adult (30-64)
Trust in elections (%, 2014)

15. • Informal is normal in Latin America
• Latin American hour: Productivity, inclusion and
governance
• Taxes and informality: in it together?
• Beyond taxes: a way forward
Informality in Latin America: Taxes and
beyond

16. Informalities
Workers
Costs > Benefits Benefits > Costs
Costs > Benefits
Firms
Benefits > Costs
Preference Exclusion
Optimal formality
Do channels exist?
Evasion
Source: Bosch, M., C. Pages and A. Melguizo (2013), Better Pensions, Better Jobs. IDB

17. • Difficulty for long-term planning
• Imperfect design of social insurance
– Not representative economic/labour model
– Enforcement (e.g. channeled through the wage bill)
• Disincentives to formality for firms/workers
– Non-wage labour costs and labour regulations
(e.g. mininum wage)
– Non-contributory benefits
• Low trust in the State and/or financial sector
• Low productivity
Informality: usual (and less usual)
suspects

18. High costs of formality (taxes and labor
regulation) could be playing a role…

19. … especially when interacting with labor
regulations
Source: Bosch, M., C. Pages and A. Melguizo (2013), Better Pensions, Better Jobs. IDB

20. Comparable statistics for 20 LAC countries on taxes on
wages:
- Social contributions (compulsory; private+public)
and personal income tax
- Formal dependent worker
- By levels of income (deciles and USD)
- By family composition (single/couple; children)
Special focus: theoretical costs (taxes) to formalise
Taxing wages in Latin America: data
first

21. Taxing wages in Latin America:
definitions
Total labour costs
- Employer social security contributions
Gross wages
-Employee social security contributions
- Personal income tax
+ Cash transfers
Net wages

22. Labour costs in LAC are heterogeneous,
and lower than in OECD (wages&taxes)
Labour costs in Latin America and OECD
(Average wage earner; social contributions and personal income tax; 2013)
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
50000
Jamaica
Nicaragua
Peru
Honduras
ElSalvador
Trinidadand
Tobago
Dominican
Republic
Guatemala
Bolivia
Mexico
Venezuela
Colombia
Ecuador
Uruguay
Paraguay
Panama
Brazil
CostaRica
Chile
Argentina
LAC
OECD
Net wages Tax wedge
Source: OECD/CIAT/IDB (2016), Taxing Wages in Latin America and the Caribbean

23. Labour costs are relatively low due to low
taxes on wages (22% vs 36%)…
Source: OECD/CIAT/IDB (2016), Taxing Wages in Latin America and the Caribbean

24. … explained by the personal income tax
(average formal worker is exempted)
Source: OECD/CIAT/IDB (2016), Taxing Wages in Latin America and the Caribbean

25. Employer contributions are alike in LAC
and OECD
0% 5% 10% 15% 20% 25% 30%
OECD
LAC
Chile
Honduras
Trinidad y Tobago
Peru
Guatemala
Ecuador
Jamaica
Bolivia
Venezuela
El Salvador
Panamá
Paraguay
Dominican Rep
Nicaragua
Uruguay
Mexico
Costa Rica
Argentina
Colombia
Brazil
Employer social contributions in Latin America and OECD
(Average wage earner; % labour costs; 2013)
Source: OECD/CIAT/IDB (2016), Taxing Wages in Latin America and the Caribbean

26. What about those who are informal?
Calculating (tax) costs of formalisation..
0%
20%
40%
60%
80%
100%
0%
20%
40%
60%
80%
100%
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
Tasa de informalidad Costo teórico de formalización
Informality and theoretical tax costs of formalisation in Latin America
(Average LAC wage earner by income decile; % wages; 2013)
Source: OECD/CIAT/IDB (2016), Taxing Wages in Latin America and the Caribbean

27. Americas Latinas
0%
20%
40%
60%
80%
100%
0%
20%
40%
60%
80%
100%
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
Chile
Tasa de informalidad Costo teórico de formalización
0%
20%
40%
60%
80%
100%
0%
20%
40%
60%
80%
100%
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
Centroamérica
Tasa de informalidad Costo teórico de formalización
0%
20%
40%
60%
80%
100%
0%
20%
40%
60%
80%
100%
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
Colombia
Tasa de informalidad Costo teórico de formalización
Source: OECD/CIAT/IDB (2016), Taxing Wages in Latin America and the Caribbean

28. Taxes and informality are correlated for low
and middle-income workers (vulnerable)
Source: OECD/CIAT/IDB (2016), Taxing Wages in Latin America and the Caribbean

29. Taxes and informality: in it together?
Theoretical indetermination and not conclusive
empirics
- minimum wage
- coordination of wage bargaining
- taxes/pensions linkage
- direct vs indirect taxes
- short vs long-term
Source: Gonzalez-Paramo, J.M. and A. Melguizo. (2013), Who pays labour taxes and social contributions? A
meta-analysis approach. SERIES, 4, 247-71

30. • Informal is normal in Latin America
• Latin American hour: Productivity, inclusion and
governance
• Taxes and informality: in it together?
• Beyond taxes: a way forward
Informality in Latin America: Taxes and
beyond

31. Procrastination and overconfidence traps
Source: Bosch, M., C. Pages and A. Melguizo (2013), Better Pensions, Better Jobs. IDB
Have you thought about financing your retirement?

32. • Difficulty for long-term planning
• Imperfect design of social insurance
– Nor representative economic/labour model
– Enforcement (e.g. channeled through the wage bill)
• Disincentives to formality for firms/workers
– Non-wage labour costs and labour regulations (e.g.
minwage)
– Non-contributory benefits
• Low trust in the State and/or financial sector
• Low productivity
Usual suspects beyond taxes

33. • Global: interactions between social protection
(pensions, health) and taxes
+ Coordination among institutions
(regulation, supervision, administration)
• Efficiency: incentives to formal labour
participation
• Innovation: supervision and compliance
mechanisms
• Transparency: simple goals; public debate
and political agreements
Principles of a pro-formality agenda

34. Incentives for formal jobs (including tax cuts)
Enforce/re-design (especially for self-employed)
Increase information and financial education
Open databases
Impact evaluation
Innovate
Comunication
Channels
Default options
Policy goals and levers

35. Better jobs: Subsidizing formal
employment…
45%
63%
Projections of formality in Latin America
Source: Bosch, M., C. Pages and A. Melguizo (2013), Better Pensions, Better Jobs. IDB

36. Better jobs: … and productive
development policies (skills)
0
10
20
30
40
50
60
70
80
90
%
Firms reporting difficulties to hire in LAC, China and OECD countries, 2014
Source: OECD/ECLAC/CAF, Latin American Economic Outlook 2017: Youth, Skills and Entrepreneurship , based on Manpower Group (2015).

37. • Informal is normal in Latin America
• 55% workers
• Also a middle-class challenge
• Addressing productivity, inclusion and governance
need formalisation
• Taxes and informality: in it together?
• Yes: taxes on wages can be burdensome, especially for the
transition informality-formality
• Beyond taxes: a way forward
– Comprehensive pro-formality package: incentives
(monetary & nudge`s) and productive development policies
Informality in Latin America: Summing up

38. • Better Pensions, Better Jobs
https://publications.iadb.org/handle/11319/462?locale-
attribute=es
• Pensions at a Glance in LAC
http://www.oecd.org/publications/oecd-pensions-at-a-glance-
pension-glance-2014-en.htm
• Taxing Wages in LAC
http://www.oecd.org/development/taxing-wages-in-latin-
america-and-the-caribbean-2016-9789264262607-en.htm
• Latin American Economic Outlook 2017
www.latameconomy.org
Main references

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