Payroll tax, Job Search and Informality∗ Zoraida Fern´andez† Ciess-econom´etrica Universidad Mayor de San Andr´es January 15, 2016

Abstract The present paper examines the quantitative effects of a labor market policy on the Bolivian economy. In addition, we study the links between demand and supply of labor in economies with informal sector; including wage bargaining by the method of Nash and worker heterogeneity with respect to formal-sector productivity. A simulation is performed for the labor market in Bolivia, using the search and matching framework elaborated by Albretch et al. (2006) which is an extension of Mortensen and Pissarides (1994). This model allows to determine the distributional consequences of a payroll tax imposed on employers, on productivity and the composition of labor market, unemployment, informal sector, and formal sector. The results show that the establishment of payroll tax implies increasing the size of informal sector.

JEL Codes: E24, E26, J64, O17 Keywords: Worker heterogeneity, matching model, informality, payroll tax

∗

This work was supported by funds from the Swiss Program for Research on Global Issues for Development (r4d

program) under the thematic research module “Employment in the context of sustainable development” and the research project “Trade and Labor Market Outcomes in Developing Countries”. The Swiss Program for Research on Global Issues for Development is being implemented jointly by the Swiss Agency for Development and Cooperation (SDC) and the Swiss National Science Foundation (SNSF). The views expressed here are the authors’ and do not necessarily reflect those of the SDC or those of SNSF. All error are our responsibility. † [email protected]

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Introduction

Empirical evidence1 indicates that applying labor policies in formal-sector variables can alter the composition of the informal sector. Approximation of these spillover effects is important, specially for economies with a significative informal sector. This paper examines the effects of a payroll tax on the composition and size of the formal sector, informal sector, unemployment and productivity distributions. We present a random-search model, whose mechanism of wage determination is the Nash bargaining method, there are no direct transitions between formal and informal sector,2 and we assume frictions in the matching process, such as informational or locational imperfections. Furthermore, we review the literature of steady state condition pertaining search and match models, deterministic equilibrium and dynamic process of adjustment to shocks. Labor market frictions in the model are described by the search and matching model developed by Albretch et al. (2006). This paper analyzes the sensitivity of some labor market variables to changes in payroll tax.3 First, this paper examines the impact of Law No 065 introducing a lineal tax in the model. The Law No 065 determines that enterprises are taxed 4.71% of payroll expenses. Second, we analyze the impact of changes in the employer contribution for 2013 as it is the nearest to a current situation that has data from household surveys. The literature that analyzes the plausible impact of labor policies is wide. Pries and Rogerson (2005) simulates the effects of labor regulation on the composition of employed and unemployed; Albretch et al. (2006) includes in this analysis the informal sector. These models are characterized by idiosyncratic shocks to productivity, labor heterogeneity and frictions. A considerable number of theoretical and empirical studies examines the dynamics of heterogeneous workers and approaches the issue of informal sector. From the Non Marshallian perspective, informality coud be modeled in several ways. First, the informal sector can be seen as disadvantaged in a segmented labor market structure. The 1

See Albretch et al. (2006), Boeri and Garibaldi (2005), Bosch (2006), Boeri and Garibaldi (2002), Satchi and Temple

(2009),Charlot et al. (2012), Zenou (2008) y Margolis et al. (2012). 2 Bosch and Esteba-Pretel (2009) y Fl´ orez (2014) performed matching models that allow direct transitions between formal and informal employment. 3 The employer contribution was eliminated by Law No. 1732 of November 1996 and reinstated by Law No 065 of December 2010.

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key papers which have contributed the main structure of this perspective, as described below, are Boeri and Garibaldi (2005), Bosch (2006), Boeri and Garibaldi (2002) and Kolm and Larsen (2003). Boeri and Garibaldi (2005)4 propose a dual deterministic model and the presence of friction, where firms create formal or informal employment depending on the cost of formality and the overall productivity of the company and the worker. The supply of labor is heterogeneous and workers choose between formality and informality according to their productivity. In addition, they examine the growth of the informal sector for some economies in the OECD, considering that the government attempts to decrease informality. Similarly, Bosch (2006) develops a stochastic matching model and concludes that workers alternate between the formal and informal sector depending on labor policies. Bosch (2006) invetigates the effects of three labor regulations: unemployment insurance, recruitment costs and payroll taxes. He also explores the impact of macroeconomic shocks on the structure of the labor market for Brazil and Mexico. Generally, the literature that assume this perspective studies the effect of monitoring and regulating the informal sector. As described by Charlot et al. (2012), Zenou (2008), and Satchi and Temple (2009) , the informal sector can be regarded as a competitive market. Charlot et al. (2012) determines the efficiency of job search and matching considering that there are no frictions in the informal sector as opposed to the formal sector. Whereas that, Satchi and Temple (2009) explains the effects of economic growth on wages in the informal sector, using a general equilibrium model. In Zenou (2008), formal workers are homogeneous and more productive on average than those in the informal sector. Additionally, Zenou (2008) justifies the absence of friction in the informal sector using empirical evidence and shows that the self-employed form the largest share of the informal sector. The latter previously cited work and Satchi and Temple (2009) explore the impact of labor policies in the formal sector on the number of unemployed and informal-sector employees. Finally, another point of view states that belonging to the informal sector is a workers’ decision originated in rational calculation. These models emphasize the voluntary nature of the worker to belong to the formal or informal sector (Albretch et al. (2006) and Maloney (2004)). The paper of Albretch et al. (2006) is particularly interesting. It includes endogenous job separations, the formal-sector workers are differentiated according to their level of productivity, and considers the 4

Boeri and Garibaldi (2005) argue that informality is an illegal activity because of tax evasion.

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informal sector as unregulated, where low-productivity workers choose to work. Similarly, Margolis et al. (2012) examines the potential impact of creating an unemployment insurance for Malaysia using as base model Diamond-Mortensen-Pissarides. They consider the existence of three sectors: the formal, informal self-employed and informal salaried; concluding that the introduction of insurance increases the average wage and also the number of self-employed. Following this line of reasoning, Kulger and Kugler (2009) present a model in which the creation of formal or informal enterprises is endogenous. In addition, they focus on the impact of tax level variations on formality, using panel data for the Colombian economy. The tax impact of labor policies is unclear. In general, payroll taxes are seen as causing reduce employment in the formal sector. Kulger and Kugler (2009) propose that the employment consequences of a payroll tax depend on the extent to which it can be passed on to workers in the form of lower wages. In addition, they estimate that only one-fifth of the tax increases affect workers with lower wages in Colombia in 1993. Hagedorn et al. (2014) extends the model of Mortensen and Pissarides (1994) adding a variable for workers’ heterogeneity with endogenous productivity and implements two changes to technology. Their model determines the response of the labor market to cyclical fluctuations in productivity and also to changes in the value of an employment tax. They show that countries with higher taxes have increased aggregate productivity and higher unemployment rates. Equivalently, Kulger and Kugler (2009)) find that an increase in the payroll tax reduces employment. Furthermore, they conclude that payroll taxes have a negative impact on formal workers with higher levels of productivity. This document follows the third perspective on informality and is organized in four sections. The following section provides a brief description of the model. We apply the equilibrium matching model of Albretch et al. (2006) and we describe the characteristics of the model with tax. In section three we discuss the implications of changes in payroll tax. We solve the model using numerical analysis. For calibration of the model we use parameters of the Bolivian economy for 2013. Finally, in the last section we present the conclusions.

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2 2.1

Model with tax Model properties

The model presented in this paper is an adaptation of the work of Albretch et al. (2006)), because it does not include an unemployment insurance tax. The model of Albretch et al. (2006) is an extension of frictions in the labor market model in Mortensen and Pissarides (1994), since they incorporate the informal sector by endogenous job separations. This section shows an outline of the standard model with tax. The presentation closely follows Albretch et al. (2006) and, for the most part, uses their notation. Then, we asume that time is continuous, workers are risk neutral with finite life and they have the same discount exogenous rate r as firms. The model essentially relates to heterogeneous formal workers and jobs, and the informal workers are self employed, so unemployed workers seek different job vacancies. After matching, the formal worker and the firm engage in bilateral bargaining over the wage. The payroll tax is denoted by τ . There are five basic assumptions of the model. First, there are frictions in the process of matching people searching for employment with job vacancies in the formal sector. These frictions are explained a matching function that is continuous, non-negative, increasing in both its arguments, and concave. Typically it is assumed to be homogeneous of degree one. This matching function is denoted by M ≡ M(V, U), where V denotes the number of vacancies and U the number of unemployed. We use the concept of labour market tightness, given by the vacancy-unemployment ratio V/U, denoted by θ. For a short term, a vacancy is found by a worker at a rate q(θ) ≡ M(V, U)/V = M(1, U/V) and
∂q(θ) θ∂q(θ) U 2 dM U > 0. Then, the matching function has elasticity in the interval ∂U = − V 2 dU 1, V < 0, ∂θ [−1.0]. Second, there is a match when the value of joint benefit (employer and employee) is greater than the sum of the benefits without agreement. Third, there is the free entry condition of vacancies. Fourth, the rate of job destruction is endogenous. Finally, workers have different potential productivity in the formal sector. Next, we explain in more detail the last three assumptions and the connection between the worker heterogeneity and the informal sector. There are two sectors in the model: formal and informal. We asume that the productivity of workers in the formal sector is heterogeneous and follows distribution function F(y) continuous and defined

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on the interval [0, 1]. Workers with a value of productivity, y which is particularly low in the interval (0 ≤ y ≤ y ∗ ) only work in the informal sector. Following this characterization, workers with medium productivity value of y such that y ∗ ≤ y < y ∗∗ accept any job opportunities, whether it be informal or formal. Finally, workers whit a productivity level in the interval [y ∗∗ , 1) accept job opportunities only in the formal sector. Next, we present a notation to explain the properties of shocks to the productivity in the model. Idiosyncratic shocks to productivity arrive at a Poisson rate λ. These shocks may be explained as shifts in demand or by productivity shocks that change the costs of production. Shocks represent a new productivity that is represented by a cumulative distribution function which depends on the initial productivity, denoted by G : P × P → [0, 1], where P is the support of the process. To ensure good definition of the conditional expectation, we assume that the support is compact.5 Following the research of Albrecht et al. (2006), unemployed workers find job opportunities in the informal sector at exogenous Poisson rate α and work in the informal sector end at exogenous Poisson rate δ. Furthermore, job opportunities in the formal sector arrive at endogenous rate m(θ). As we indicated previously and according to Mortensen and Pissarides (1994), shocks to the productivity occur at exogenous rate λ and are identically and independently distributed. The productivity of the job moves from its initial value x to some new value x0 , which is a drawing from a general distribution G(x) with support in the range 0 ≤ x ≤ y. Observe that match productivity varies over time but may not exceed its initial value. This assumption is reflected in the restrictions on the range of y 0 and G(y) normalization. The reservation value is an endogenous variable defined as the estimated best alternative in case of disagreement and denoted by R. If productivity is less than R, then, the relationship between the enterprise and employee ends. Once a shock arrives, the firm either continues production at the new value or closes the job down. The capacity of shocks to break up the match is defined in terms of an endogenous reservation productivity, R(y), which depends on the worker’s type. Thus, we can consider three states: 1. If x is sufficiently low, then the match breaks up. A shock ends worker y’s match with probability G(R(y)). 5

Following the notation of Shimer (2005). Let EXp0 denote the expected value of an arbitrary variable X following

the next aggregate shock, conditional on the current state p.

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2. If R(y) ≤ x ≤ y, then the productivity of the match changes to x. That occurs with probability G(y) − G(R(y)). 3. If x > y, then then the productivity of the match reverts to y. That occurs with probability 1 − G(y). We define the functions of demand and supply of labor in the context of the model developed by Albretch et al. (2006). These functions are a set of Bellman’s equations. We consider that a worker can only belong to one of the following states: formal-sector employed, informal-sector employed or unemployed. Unemployed workers receive a flow income of b which represents the value of leisure. Informal-sector workers receive a flow income y0 > b. Employed in the formal-sector workers earn a wage w(y 0 , y) where y 0 is the productivity of the match and y is the productivity of the worker. rWF (y 0 , y) is the permanent income of employed workers of type y in a match that has current productivity y 0 . Let rWI (y) be the value of informal-sector employment for a worker of type y and rU (y) be the value of unemployment for a worker of type y. The worker’s value functions are given by: rWF (y 0 , y) = λG(R(y))(U (y) − WF (y 0 , y)) + λ

y

Z

(WF (x, y) − WF (y 0 , y))g(x)dx

R(y) 0

+λ(1 − G(y))(WF (y, y) − WF (y , y)) + ω(y 0 , y) rWI (y) = y0 + δ(U (y) − WI (y))

(1) (2)

rU (y) = b + αmax[WI (y) − U (y), 0] + m(θ)max[WF (y) − U (y), 0]

(3)

Let J(y 0 , y) be the value of a filled formal-sector job with a worker type y in a match with current productivity y 0 , V be the value of creating a formal-sector vacancy, and c represents the cost of holding an unfilled formal vacancy. Then, the value to the firm of a filled formal job or holding a vacancy are defined as follows: 0

0

0

Z

y

rJ(y , y) = y + λG(R(y))(V − J(y , y)) + λ

(J(x, y) − J(y 0 , y))g(x)dx

R(y)

+λ(1 − G(y))(J(y, y) − J(y 0 , y)) − ω(y 0 , y)(1 + τ )

(4)

m(θ) rV

= −c +

θ

max[(EJ(y, y), V ) − V ]

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(5)

Bellman equations (1)-(4) are consistent with the searching and matching process, and with properties of the shocks that we have previously established. The expression (5) implies that the value of vacancy is equal to profit when the company filled the place with worker type y minus the cost to maintain the vacant position, ie, EJ(y, y) ≥ V . Clearly, equation (5) states that the initial productivity of the match is equivalent to the level of worker productivity. As usual in this type of model, we assume the free entry condition. This condition implies that the cost of post a vacant is equal to the capitalized value of profits flow to maintain a vacancy for a period, i.e. the expected cost of posting a vacancy is equal to the expected return. V = 0 determines the equilibrium value of labour market tightness.

2.2

Wage determination and reservation productivities

Matching Frictions imply that a firm and a worker generate a rent. We assume that this rent is shared according to the Nash (1950) solution to a bargaining problem. The parameter derived from the wage function β ∈ (0, 1) is exogenous and indicates worker participation (workers’ bargaining power). The Nash bargaining problem is given by: ω(y 0 , y) = arg max{(WF (y 0 , y) − U (y))β (J(y 0 , y) − V )1−β } The first-order maximization condition implies that,6 ω(y 0 , y)(1 + τ ) = r(1 + τ )U (y) + β(y 0 − r(1 + τ )U (y) − (r + k(λ, G(R(y)), g(x), G(y))V, and using the free entry condition (V = 0), the wage is then given by: βy 0

0

ω(y , y) = (1 − β)rU (y) +

1+τ

Thus, the wage is a weighted average of productivity in the match and the flow value of an unemployed worker. As described previously, reservation productivity is defined by the condition of zero surplus and is represented as follows: WF (R(y), y) − U (y) + J(R(y), y) = 0 6

See Binmore et al. (1986) for applications of the Nash bargaining solution in economic modelling.

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Consequently, when a shock to the productivity is sufficiently unfavorable filled jobs can be destroyed. That equals J(R(y), y) = 0. Therefore, (r + λ)G(y)(1 + τ )rU (y) − λ R(y) =

R

y R(y) (1

− G(x))dx + (G(y) − 1)y

 (6)

rG(y) + λ

If θ is fixed, reservation productivity has a unique solution. Note that the higher is the value of the payroll tax (τ ), the greater is the value of reservation productivity. Equation (6) is important for the model because it provides information of reservation productivity in terms of the labour market tightness and other model parameters. Thus, knowledge of v/u can be used to derive the rate of job destruction. Note that the greater the potential productivity y, the greater the flow of capitalized utilities, specifically for U (y). This suggests that R(y) is increasing in this argument. However, the second term of equation (6) suggests that R(y) should be decreasing in y.

2.3

Steady-state conditions

According to the characteristics of workers at intervals of productivity, we obtain that, y ∗ is defined by the following condition, y = y ∗ , that is, the worker is indifferent between being unemployed or employed in the formal sector. Moreover, y ∗∗ is defined by the condition that worker productivity is y = y ∗∗ . We consider a worker with productivity y ∗ ≤ y ≤ y ∗∗ , consequently rU (y) = b + α(WI (y) − U (y)) + m(θ)(WF (y, y) − U (y)). Using the following condition WF (y ∗ , y ∗ ) = U (y ∗ ) and solving gives, rU (y ∗ = b + α(WI (y ∗ ) − U (y ∗ )). Therefore, rU (y ∗ ) =

b(r + δ) + αy0 r+δ+α

,

equating to, WF (y ∗ , y ∗ ), we obtain: y ∗ = (1 + τ )

b(r + δ) + αy0 r+δ+α

λ −

Z

(r + λ)G(y ∗ )

y∗

(1 − G(x))dx

(7)

R(y ∗ )

So as before: rU (y ∗∗ ) = b + m(θ)(WF (y ∗∗ , y ∗∗ ) − U (y ∗∗ )), and using WI (y ∗∗ ) = U (y ∗∗ ), it follows that: WF (y ∗∗ , y ∗∗ ) =

y0 (r + m(θ)) − rb rm(θ) 8

Hence,

y

∗∗

(1 + τ )(rG(y ∗∗ ) + λ) =

βm(θ)G(y ∗∗ )

λ (y0 − b) + (1 + τ )y0 −

Z

(r + λ)G(y ∗∗ )

y ∗∗

(1 − G(x))dx

(8)

R(y ∗∗ )

We now analyze the case of a worker with a productivity level y, such that y ∗ ≤ y < y ∗∗ , solving gives:   β(r + δ)m(θ)  λ Ry  (b(r + δ) + αy0 )(rG(y) + λ) + (1 − G(x))dx G(y)y + 1+τ r + λ Ry rU (y) =

(r + α + δ)(rG(y) + λ) + βG(y)(r + δ)m(θ)

Finally, if worker productivity is such that y ≥ y ∗∗ , we have: βm(θ) b(rG(y) + λ) + rU (y) =

λ (G(y)y +

Ry

1+τ r + λ R(y) λ + (r + βm(θ)G(y))

(1 − G(x))dx)

Note that if θ is fixed, then there are unique values for y ∗ and y ∗∗ . Given the equation (6), the differing forms for rU (y) imply different levels of R(y). In what follows we present the steady state conditions. We use the steady state conditions for determining unemployment rates for different types of workers. Let u(y) be the fraction of time a worker of type y spends in unemployment, let wI (y) be the fraction of time that this worker spends in informalsector employment, and let wF (y) be the fraction of time that this worker spends in formal-sector employment. We have, u(y) + wI (y) + wF (y) = 1. First, the steady-state condition for workers with productivity y : y < y ∗ is: αu(y) = δ(1 − u(y)). Consequently, δ u(y) =

δ+α

α ,

wI (y) =

δ+α

,

wF (y) = 0.

Second, there are two steady-state conditions for workers with y : y ∗ ≤ y ≤ y ∗∗ . We have, αu(y) = δwI (y) m(θ)u(y) = λG(R(y))(1 − u(y) − wI (y)).

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As a consequence, δλG(R(Y )) u(y) =

λ(δ + α)G(R(y)) + δm(θ) δm(θ)

wF (y) =

λ(δ + α)G(R(y)) + δm(θ) αλG(R(y))

wI (y) =

. λ(δ + α)G(R(y)) + δm(θ)

Finally, the steady-state condition for workers with productivity y > y ∗∗ is: m(θ)u(y) = λG(R(y))(1 − u(y)). Thus, λG(R(Y )) u(y) =

λG(R(y)) + m(θ) m(θ)

wF (y) =

λG(R(y)) + m(θ) wI (y) = 0.

2.4

Equilibrium

We use the free entry condition (V = 0) to determine the point of equilibrium in the labor market. This equilibrium also implies that steady-state conditions and cutoff productivity conditions are satisfied. A match in the formal sector is not suitable for workers with productivity y : y < y ∗ and analogous to the informal sector. Let fu (y) denote the density of types among the unemployed. Using Bayes’ Law and setting V = 0, the free-entry condition can be re-written: 

 y − R(y)   u(y) (1 − β)  f (y)dy  r+δ u y∗

m(θ) Z c=

θ

1

(9)

Thus, the optimal strategy of the firm to post a vacancy is given by the function (9). The equilibrium exists if there is a θ which solves the equation (9). Remember that, R(y), u(y), m(θ) and u

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depend only on the value of θ.7 . Thus, when θ → ∞, the solution of equation (9) approaches zero and when θ → 0, the solution of equation (9) tends to infinity. Therefore, given a c > 0, by the mean value theorem exists θ∗ ∈ [0, +∞) such that the solution of equation (9) for the value θ equals c. The uniqueness of the model is verified by showing that the equation (9) is monotonically decreasing in θ. Note also that the necessary condition for the equation (9) has only solution is y ∗ < 1, since J(y) is increasing in y when y ≥ y ∗ and setting J(y ∗ ) = 0, we have:

(1 + τ )

b(r + δ) + αy0 r+α+δ

<1

(10)

Hence, the existence of match depends on the value of τ . If τ is high enough, no formal-sector matches form. In that case, equation (9) cannot hold, and the only equilibrium is one in which all employment is in the informal sector. Then, given the functional forms F (y), G(y) and a function of matching the equation (9) can be solved for θ. Once we solve for equilibrium, we can compute the steady-state distributions of productivity and wages in formal-sector employment. We determine the characteristics of the distribution functions using the marginal density of worker type and the joint density of current productivity and worker type. Then, we determine the conditional and marginal density of formal-sector workers. Subsequently, we use steady-state conditions for obtain the probability that a informal worker type y work at its potential level, the densities of productivity and the distribution of wages across formal-sector employment. We conclude that the distributions of current productivity and wages given y both have mass points.

3

Simulations

3.1 3.1.1

Simulation of Law No 065 Model calibration

In this section, we present the values of exogenous parameters, the time unit is the year. The functional forms employed are described in Section 2.1. Our parameter values were chosen to produce plausible results for our baseline case in which there is a payroll tax rate of 1.71 percent. 7

R(y) is monotonically increasing in θ, u(y) is monotonically decreasing in θ for y ≥ y ∗ and

decreasing in θ

11

m(θ) θ

is monotonically

• The flow of “new employees” is given by m(v, u) that is a function of constant returns to scale.

We assume Cobb-Douglas as the functional form of the matching function.

Then,

m(u, v) = µu1−η v η , f (θ) ≡ m(1, θ) = µθη . Technology and elasticity parameters for the CobbDouglas function take conventional values. The elasticity value is 0.5.8 This value is justified according to the Hosios condition for an efficient search9 that establishes the relationship between the bargaining power of workers and the elasticity of the matching function with respect to unemployment. The coefficient of technology is 7. • We use a discount rate equivalent to 1.1% which corresponds to the annual fixed desposit rate in 2010.10 • In accordance to the literature, we assume that the value of bargaining power is β = 0.5. Note that we do not have a reliable magnitude for parameters representing the bargaining power of workers neither of the cost of the vacancy (c). This cost essentially closes the model and is c = 0.3. • The flow income equivalent of leisure is b = 0. • y0 = 0.6. Appendix B provides the description of the definition of informality used for the model. • δ = 0.27 and α = 0.21.11 3.1.2

Effects of Law No 065

In this section, we present the numerical analysis and evaluate the effects of changes in payroll tax in order to explain the effects of Law No 065. According to the model, a payroll tax acts directly on the utility function of the firm. In addition, the tax has an impact on the utility of workers. Specifically, it modifies the equilibrium wage. Therefore, this tax has an effect on reservation productivity, cutoff productivities, employment duration in the formal sector, and the size and composition of the informal sector, formal sector and unemployment. 8

Following, Albretch et al. (2006), Dolado et al. (2007), Mortensen and Pissarides (1994) y Petrongolo and Pissarides

(2001). 9 See Hosios (1990). 10 Source: Banco Central de Bolivia. 11 See Gomez (2016).

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The baseline case reflects the values of the variables before the increase of 3% on employer contributions due to the Law No 065 , ie τ = 1.71%. Table 1 shows the baseline case in the first row for 2010 and the simulation for 2011 in next row. in 2011, according to the simulation, 68.44% of the work force is employeed in the informal sector. This value is consistent with INE’s Household Survey records that indicate a percentage of 68.83. The unemployment rate in the model equals 3.72%. This rate approximates the value suggested by the official records, equivalent to 3.78%. A comparison between the corresponding statistics reveals that a 3% increase in payroll taxes (employer contribution) decreases the labour market tightness by 5%. Furthermore, this increase has consequences for the composition of the labor market and the duration of employment of formal-sector workers. Thus, the proportion of low-productivity workers (who only take informal jobs) increased by 3% preventing workers’ mobility towards the formal sector. Column 3 of Table 1 shows the results above. y ∗ and y ∗∗ indicate the cutoff productivities. Before applying the tax, the fraction of highly productive workers was 27%, after the promulgation of Law No 065 this value decreases to 25%. We also note that this law increases the average duration of employment in the formal sector ( from 32.75 to 32.81 months), and also increases the unemployment duration in about 2 days. The duration of a vacancy decreased from 2.27 to 2.20 months. The tax has no significant effect on the overall unemployment rate. Evidently, the unemployment rate for workers with low productivity is constant and has a value of 3.58%.

3.2

Tax experiments

In this section, we detail the sensitivity of some labor variables to changes in the employer contribution. We perform simulations for the year 2013 as an attempt to reflect a current scenario. The performance of the model in matching calibration targets is described in Table 2. The calibration is consistent with unemployment in Bolivia for the year 2013 as the model suggests a cifre of 4.09% and the value suggested by the official records is 4.08%. Table 3 shows the effect of increasing the payroll tax, τ . We consider variations in the interval [0.0471 − 0.0671], we observe that the increase of τ reduce the labour market tightness, since the job creation in the formal sector is less attractive.

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The first row of Table 3 shows the baseline case, in this scenario the labour market tightness θ = 1.46). The labour market tightness indicates that the growth rate of job creation is greater than the growth rate of job destruction, that means that the productivity of workers is inadequate for the match. Approximately 57% of the workforce has low productivity, preventing their mobility, whereas 15% of the labor force works only in the formal sector. In the work of Albretch et al. (2006) the value of workers with high productivity was equivalent to 60% for the Mexican economy. Informal-sector workers are n0 = 59% of the workforce, according to the household survey this value was 58.9% in the year 2013. Reservation productivity for workers who make the decision between formal and informal employment is R(y ∗∗ ) = 0.5938 > R(y ∗ ) = 0.5699. This suggests that workers with higher levels of productivity have a higher profit if there is no match compared to workers with lower levels of productivity. The average productivity of workers in the formal sector is 0.8017. Table 4 presents the unemployment rate of workers according to their level of productivity and the duration of employment and unemployment for workers in the formal sector measured in months. The first row of Table 4 shows the baseline case. Our baseline average unemployment duration is 1.53 months. The unemployment rate for workers with medium productivity is 0, 025 and 0.0445 for high-productivity workers. The unemployment rate for workers with medium productivity is lower than the unemployment rate for workers with high or low productivity. This shows that the medium productivity workers have the choice of finding jobs in both sectors. While the rate of unemployment of low-productivity workers is constant and has a value equivalent to δ/(α + δ) = 4.17%, the unemployment rate hight-productivity workers is volatile in percentage terms. Our findings show that a 10% increase in payroll tax reduces formal employment by 1%. Due to this neutralizing effect, there are not increases in total unemployment. The next four rows in Tables 3 and 4 show the effect of increasing the employer contribution rate from 4.71% to 6.71%. Table 3 and Figure 1 shows that the increase in the payroll tax implies reductions on labor market tightness. Total unemployment rate remains constant with small tax changes, nevertheless, unemployment of workers with high productivity increases. The increase in employer contributions has two substantial effects. First, the composition of the labor market. The proportion of workers who do not accept job opportunities in the formal sector (limit y ∗ ) increased by 2% with an increase of two percentage points of tax. Similarly, the proportion of the formal sector decreases. Second, the duration of employment in the formal sector. The payroll tax

14

decreases average employment duration in the formal sector.

4

Conclusions

Due to lack of empirical data on labor demand and the cost of vacancy there is no empirical basis to explain the consequences of a payroll tax in Bolivia on the composition of formal, informal sector and unemployment. However, the model Albretch et al. (2006) enables understanding of a labor market with frictions and an informal sector in the abcense of comprehensive data. The numerical solution elaborated in this paper indicates that Law No 065 implemented in 2011 does not affect the overall unemployment level. However, there is an increase by 3.2 percent in the size of the informal sector and also in the number of workers who take jobs in both the formal and informal sector. This labor policy also has an impact on the duration of employment in the formal sector, increasing it by 0.2%. We conclude that a payroll tax reduces the rate at which workers find job opportunities in the formal sector and increases the average productivity of workers. In accordance with Albretch et al. (2006), Boeri and Garibaldi (2002), Bosch (2006), Dolado et al. (2007) and Fl´orez (2014), a payroll tax increases incentives for a worker to be informal and, as a result, the formal sector decreases.

15

References Albretch, J., Navarro, L., and Vroman, S. (2006). The effects of labor market policies in an economy with an informal sector. IZA, (2141). Binmore, K., Rubinstein, A., and Wolinsky, A. (1986). The nash bargaining solution in economic modelling. RAND Journal of Economics, pages 176–188. Boeri, T. and Garibaldi, P. (2002). Shadow activity and unemployment in a depressed labour market. CEPR Discussion Paper, (3433). Boeri, T. and Garibaldi, P. (2005). Shadow sorting. in: Nber international seminar on macroeconomics 2005. MIT Press, pages 125–163. Bosch, M. (2006). Job creation and job destruction in the presence of informal labour markets. CEP Discussion Paper, (761). Bosch, M. and Esteba-Pretel, J. (2009). Cyclical informality and unemployment. CIRJE Discussion Papers, 613. Charlot, O., Malherbet, F., and Ulus, M. (2012). Efficiency in a search and matching economy with a competitive informal sector. IZA, (6935). Dolado, J., Jansen, M., and Jimeno, J. (2007). A positive analysis of targeted employment protection legislation. IZA, (2679). Fl´orez, L. (2014). The search and matching equilibrium in an economy with an informal sector: A positive analysis of labor market policies. Borradores de econom´ıa, (821). Gomez, E. (2016). Transiting from inactivity to informality. Unpublished manusprict. Hagedorn, M., Manovskii, I., and Stetsenko, S. (2014). Taxation and unemployment in models with heterogeneous workers. Hosios, A. (1990). On the efficiency of matching and related models of search and unemployment. Review of Economic Studies, 57(2):279–98.

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Kolm, A. and Larsen, B. (2003). Social norm, the informal sector and unemployment. FinanzArchiv, 59:407–424. Kulger, A. and Kugler, M. (2009). Labor market effects of payroll taxes in developing countries: Evidence from colombia. The University of Chicago. Maloney, W. (2004). Informality revisited. World Development, 32(7):1159–1178. Margolis, D. N., Navarro, L., and Robalino, D. A. (2012). Unemployment insurance, job search and informal employment. IZA, (6660). Mortensen, D. and Pissarides, C. (1994). Job creation and job destrucion in the theory of unemployment. Review of Economic Studies, 61:397–495. Petrongolo, B. and Pissarides, C. (2001). Looking into the black box: A survey of the matching function. Journal of Economic Literature, 39:390–431. Pries, M. and Rogerson, R. (2005). Hiring policies, labor market institutions, and labor market flows. Journal of Political Economy, 113(4):811–839. Satchi and Temple (2009). Labor markets and productivity in developing countries. Review of Economic Dynamics, 12(1):183–204. Shimer (2005). On the job search and strategic bargaining. Working paper, U. of Chicago. Zenou, Y. (2008). Job search and mobility in developing countries. theory and policy implications. Journal of Development Economics, 68(2):336–355.

17

A

Law No 065

Article 91 of Chapter II of the Pensions No 065 indicates that the employer must pay from their own resources the following taxes: a premium for occupational risk of dependents and a solidarity employer contribution. First, the contribution of professional risk premium long-term has a value of 1.71% destined for collective account of professional risk. Second, the solidarity employer contribution is 3 percent of the payroll expenses destined for the solidarity fund. This article also states that the employer acts as withholding agent of insurance contributions, insurance solidarity contributions and common risk premium contribution.

B

Informality

We adopt the definition of CIESS-Econometrica, considering that an informal employee is one who belongs to the union of the following sets: 1. Labourers who do not receive monthly pay compensation. 2. Employees who do not receive monthly remuneration and work with five workers or less. 3. Employers with five employees or less. 4. Employers who do not receive monthly remuneration and work with five employees or less. 5. Employers who receive no remuneration and work with five employees or less for seven days a week. 6. Members of a cooperative. 7. Non-salaried workers. 8. Domestic workers. 9. Self-employed workers with 17 or fewer years of education. 10. Own-account workers with 17 or fewer years of education.

C

Tables and Figures 18

Productivity

Composition

tax

θ

y∗

y ∗∗

R(y ∗ )

R(y ∗∗ )

n0

n1

0.0171

1.4120

0.6318

0.7272

0.6318

0.6535

0.6632

0.2995

0.0471

1.3400

0.6504

0.7504

0.6504

0.6725

0.6844

0.2784

Table 1: Productivity and Composition of worker types in the two sectors

Informal sector

Formal sector

Otros par´ ametros

δ

α

y0

c

β

λ

r

µ

η

0.300

0.240

0.130

0.200

0.500

0.500

0.026

7.000

0.500

Table 2: Model parameters

Productivity

Composition

tax

θ

y∗

y ∗∗

R(y ∗ )

R(y ∗∗ )

n0

n1

0.0471

1.4600

0.5699

0.6588

0.5699

0.5938

0.5922

0.3668

0.0521

1.4600

0.5726

0.6619

0.5726

0.5966

0.5950

0.3640

0.0571

1.4480

0.5753

0.6653

0.5754

0.5494

0.5981

0.3610

0.0621

1.4480

0.5781

0.6684

0.5781

0.6023

0.6009

0.3581

0.0671

1.4360

0.5808

0.6718

0.5808

0.6051

0.6040

0.3551

Table 3: Productivity and Composition of worker types in the two sectors

Unemployment

Duration formal employment

tax

umed

uhigh

utot

u

vacancy

employment

0.0471

0.0225

0.0445

0.0409

1.533

2.237

32.594

0.0521

0.0225

0.0445

0.0409

1.533

2.238

32.691

0.0571

0.0226

0.0447

0.0410

1.539

2.228

32.700

0.0621

0.0226

0.0447

0.0409

1.539

2.228

32.698

0.0671

0.0226

0.0449

0.0410

1.545

2.219

32.709

Table 4: Unemployment and average employment duration in the formal sector

19

Figure 1: Composition of employment in the informal and formal sector

Figure 2: Average employment duration in the formal sector and payroll tax Informal

Formal

0.771 0.623 0.48

0.475 0.326 0.178 tax

0.0521 0.0621 0.0871 0.1271 0.1671 0.2071 0.2471 0.2871

Figure 3: Composition of employment in the informal and formal sector

20

Figure 4: Productivity and payroll tax

21