Switching from Payroll Taxes to Corporate Income Taxes

Apr 2017
The Colombian 2012 tax reform reduced payroll taxes and employer contributions to health insurance by 13.5%, while also increasing corporate income taxes, and leaving untouched the benefits to workers financed through these taxes. Shifting taxation from formal employment to other business activities is a policy recipe under heated discussion in Latin America. In this context, the reform offers an ideal laboratory to study empirically the potential distortions against formal employment associated with payroll taxes in contrast to other taxes to firms. Using monthly firm-level data on all formal employment in the country, and a difference-in-difference approach that takes advantage of the fact that a few sectors were exempt from the 2012 tax reform, we analyze the impact of the reform on employment and wages. We find a positive average effect of 4.3% on employment and of 2.7% on average firm wage, for the average firm. The employment effect is identified only for micro and small firms, while we do not find a significant employment effect for medium and large firms, where the bulk of the employment is concentrated. According to these estimates, between January and May of 2015 about 145K new jobs were created by virtue of the reform. Though our findings on employment are less robust than those on wages, they are generally supportive of efforts to reduce payroll taxes, which are still high in the country. Since the apparent lack of effect for medium and large employers may be due to these firms being more sensitive to the increase in corporate taxation that financed the reduction in payroll taxes, our results also raise concerns about this particular way of financing the reform, especially formedium and large firms, which according to our data represent 70% of formal employment.