By Jens Matthias Arnold and Paula Garda, OECD Economics Department
After a severe economic crisis in 2020, Colombia’s economy recovered strongly in 2021 and activity levels now exceed pre-pandemic levels. Having trailed behind for some time, employment has now increased visibly as well, albeit led by informal jobs. By now, 95% of the jobs destroyed during the pandemic have been recreated.
Colombia has suffered from high poverty and social exclusion for a long time, and the pandemic has only exacerbated these challenges: only 14% of vulnerable households received social transfers before the crisis (Figure 1), and 60% of workers are in informal jobs, with no access to unemployment or pension benefits.
Figure 1. Many vulnerable households are left behind
The government expanded social spending during the pandemic and managed to partly cushion the negative impact on incomes, employment and poverty. Still, incomes of households in the lower end of the income distribution fell three times more than for other income segments during 2020 (Figure 2). This has exacerbated what is the OECD’s most unequal income distribution and pushed the poverty rate up to 42.5%.
Figure 2. The pandemic had serious social consequences
A strong and inclusive recovery requires more and better jobs, but also more and better social protection for all Colombians. Offering universal benefits for formal and informal workers alike will be crucial to achieve that. Instead, the current system generates a vicious cycle by which informal workers are excluded from the social security benefits, while informality is perpetuated through high contributions and non-labour wage costs that finance benefits for formal workers. Non-wage labour costs can amount to 55% of take-home wages for workers earning the minimum wage, raising the cost of formal job creation significantly.
The results of the current dual social protection system is that only 28% of pension-age adults receive a formal old-age pension, while 20% of all public revenues are spent to subsidise the pensions of a privileged 4% of the population. Another 25% of pension-age adults receive a meagre non-contributory pension, at only 60% of the extreme poverty line.
These weaknesses in the social protection system are also one factor behind another structural challenge for Colombia: low productivity, whose growth has been less than half the Latin American average over the last three decades. Firms that cannot or seek to avoid paying social security contributions will remain small and less productive, in order to fly below the radar of tax authorities.
To break the vicious circle of informality, it is important to advance towards universal non-contributory social protection benefits available to formal and informal workers. This could be done by establishing a universal basic pension combined with a guaranteed minimum income benefit that would build on the “Familias en Acción” programme and extend existing cash transfers to low-income households. At the same time, the financing burden of social protection should gradually shift from social security contributions towards general taxation, reducing the disincentives for formal job creation. Cutting non-wage labour costs can be important catalyst of formalisation, as a 2012 reform has vividly demonstrated. Informal workers, with incomes below or close to the minimum wage, would reap the greatest benefits from such reform, as they would obtain better employment and income opportunities and would no longer be excluded from social protection.
OECD calculations suggest that such a reform would require about 1% of GDP in additional tax revenues in the long run. This will require rebalancing the tax system. For one, multiple exemptions and tax benefits could be reduced to limit tax expenditures and strengthen tax revenues. Beyond that, reducing social security contributions and giving a greater role to personal income taxes would be key.
Colombia could raise more revenues from personal income taxes by lowering the income threshold where taxpayers start paying, eliminating exemptions and strengthening rate progressivity. Colombia raises only 19% of GDP in taxes, compared to 34% in the rest of the OECD, and personal income taxes account for only 6% of tax revenues, four times less than in the OECD.
Such social protection and tax reforms would not only allow reducing informality, but also make substantial inroads in the fight against poverty and inequalities, while boosting the growth potential of the economy.
Progress along this road will not be easy and will need to be gradual, as it will require generating a broad consensus around a new long-term vision for social protection. But Colombia cannot afford to delay designing a roadmap for this reform, if it wants all Colombians to enjoy social protection, better jobs, higher earnings and more productive firms.
References
OECD (2022), OECD Economic Surveys: Colombia 2022, OECD Publishing, Paris, https://doi.org/10.1787/04bf9377-en.
For more information: http://oe.cd/colombia