# **1. Introduction**

Social protection systems in Latin America are typically truncated: a formal component of contributive or capitalized insurance covering multiple risks exists alongside a combination of assistance-based social programs that are frequently disarticulated or redundant and have differing degrees of impact upon the most vulnerable (World Bank, 2007). Important design faults persist in the existing social insurance schemes: discrepancies between contributions and service quality, excessive benefits packaging, and rigidity in approaches to mobility or compulsoriness, among others (World Bank, 2007). In the last two decades, efforts to improve and rationalize social protection in the Latin American region have included revising the generosity of the benefits bestowed and evaluating the individual (or mixed) capitalization systems in the case of social security. They also have focused on improving the targeting of social programs aimed at the poor (to avoid errors of inclusion), while also expanding them to cover the greatest possible number of poor people (to avoid errors of exclusion), in the majority of cases through the use of conditional monetary transfers.

There have recently been calls for a more integral vision for public policy on social protection. Levy (2007, 2008), the World Bank (2007), Cunningham (2007) and Bernal et al., (2009) argue that there are important interactions between social protection design and the structure of the labor market and, therefore, between social security and employment, productivity, and growth. At the center of these interactions is the fact that the social protection system is articulated around labor status, with social security associated with formality and social assistance programs associated with informality. If individuals value sufficiently the free insurance provided by noncontributive schemes, the dual system will incentive informality. With increasing informality, formal workers and public finances will have mounting pressures to support the social assistance scheme at a time of declining formal contributions. In those contexts, the co-existence of contributive insurance programs and subsidized or assistance insurance programs creates a perverse subsidy to informality and a tax for formality. Although those perverse interactions have not yet been quantified in any country, some approximations in Mexico suggest that they could be considerable (Levy, 2007).

This paper adds to the understanding of these relationships by quantifying the implicit taxes and subsidies on workers associated with social security and social assistance in Colombia. Colombia is an interesting case study for various reasons. Firstly, Colombia’s social protection spending trends are unusual in the Latin American region. Its public spending has increased rapidly—in fact, it is the country in the region that has seen greatest growth since the 1990s—thereby enabling it to eliminate its historic gap with respect to the Latin American average. This rise has been fundamentally caused by an increase in social security spending, whereas spending on social assistance has been stagnant since the 1990s. That allocation of social spending contrasts with the ambitious conceptualization of lifelong comprehensive risk protection _and_ fight against extreme poverty that Colombia purportedly pursued. Secondly, Colombia has experienced dramatic increases in the coverage of health care insurance while a disappointed stagnation at low levels of pension coverage. Thirdly, Colombia has very high labor costs as a percentage of the payroll (76 percent of the basic minimum salary according to calculations made by Nuñez [2008]), part of which are linked to financing social security for contributing workers and the rest for social protection for poor people (therefore, not linked to the worker). The fact that Colombia has very high dismissal costs even for Latin American standards (Cunningham, 2007) –although with some recent progress in terms making hiring, firing and working hours more flexible (World Bank 2010)– and a minimum salary that is also high according to regional standards (Maloney and Nuñez, 2004) 2