Switching from Payroll Taxes to Corporate Income Taxes: Firms’ Employment and Wages after the 2012 Colombian Tax Reform

ABSTRACT: The 2012 Colombian tax reform reduced payroll taxes and employer contributions to health insurance by 13.5 percent, 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. The reform offers an ideal laboratory for studying empirically the potential distortions against formal employment associated with payroll taxes in contrast to other taxes on firms. We analyze the impact of the reform on employment and wages using monthly firm-level data on all formal employment in nonpublic firms in the country and a difference-in-differences approach that takes advantage of the fact that a few sectors were exempt from the 2012 tax reform. We find a positive average effect of 4.3 percent on employment and 2.7 percent on average firm wages, for the average firm. The employment effect is found only for micro and small firms, whereas the bulk of the employment is concentrated in medium and large firms, which show no significant effect. According to these estimates, about 145,000 new jobs were created between January and May of 2015 by virtue of the reform. These results are generally supportive of efforts to reduce payroll taxes, though our findings on employment are less robust than those on wages, and large firms do not seem to have benefitted. The apparent lack of effect for medium and large employers is also a source of concern. We speculate that it may be due to these firms’ being more sensitive to the increase in corporate taxation that financed the reduction in payroll taxes, but lack of access to the relevant data prevents us from offering solid evidence regarding this hypothesis.