The Effect of Social Security Contributions on Coverage and Wages: A Gender Perspective Using a Natural Experiment from Colombia

[Author Affiliation]Andres J Vargas, , , , andres.vargas@ttu.edu[Acknowledgment]I would like to thank Steve Trejo, Dan Hamermesh, Gerald Oettinger, Jacqueline Angel, Dan Slesnick, Adriana Kugler, Stefano Farne, two anonymous referees, and seminar participants at the University of Texas at Austin, the Second Conference on aging in the Americas, and Texas Tech University, for their insightful and valuable comments. I am also grateful to Cesar Caballero and Alejandra Corchuelo from the Colombian National Department of Statistics DANE for providing me with the data. All remaining errors are mine.1. IntroductionTheoretically, social security contributions are considered a benefit-linked payroll tax because of the connection between the taxes paid by or on behalf of each worker and that individual's expected benefits. Hence, with the presence of tax-benefits linkages workers receive a higher compensation, and the contributions are analogous to a price paid for a privately supplied commodity (Summers 1989). A general payroll tax, on the other hand, has no linkage to benefits for the individual taxpayer and therefore carries efficiency costs. The benefit linkages of social security contributions depend on the extent to which workers perceive that they are getting the contributions back as benefits and on how much the individual values those benefits. This depends in turn on the quality of the services offered by the entities financed by the tax. If they are perceived as good, employees will consider the contributions as a deferred compensation or insurance program and will accept a reduction in the net wage with no employment effects. If they are perceived as bad, the contributions will be considered as a pure tax with the corresponding effects on employment (Kesselman 1997). The objective of this article is to investigate, from a gender and marital status perspective, the effects of pension and health care contributions on the employment and wages of workers covered by social security regulations.It is interesting to study Colombia because the country implemented a large social security reform in 1993 that allows the identification the labor market effects of these contributions. Furthermore payments for pension and health care provisions amount to a quarter of the wage bill there. This, in conjunction with an 11% average contribution for other payroll taxes, positions Colombia as the country with the highest payroll tax rate in Latin America.The end of the 1980s and early 1990s was a period of deep structural transformations in Latin America. These reforms were part of efforts to liberalize economies and increase the participation of the market in the production and allocation of goods and services and were the product of the collapse most economies in the region experienced during the 1980s due to their mounting fiscal and monetary imbalances (Heckman and Pages 2004). These large exogenous shifts in policy regimes offer very good case studies of the interaction between institutions and labor market outcomes. The main reforms in Colombia during this period included the approval of a new constitution, key reforms to the labor market, a major trade reform, and liberalization in direct foreign investment.More than two years after these reforms were put in place, Colombia implemented a social security reorganization that transformed the institutional framework for pension funds and health care provision (Law 100 of December 1993). Regarding the health care regime, the social security reform replaced the existing discretionary affiliation system that covered only the worker, with a mandatory one that features a stricter prepayment system and covers also the family of the worker. On the subject of pensions the reform introduced a fully-funded social security system and gave the workers the choice between this new scheme of individual capitalization of public funds and the existing pay-as-you-go system. …