2. Filling in the gaps: expanding social protection in Colombia
The pandemic has highlighted significant gaps in social protection, in particularly among informal workers. With around 60% of workers in informal jobs, many of those most in need of social protection are left behind. The government has attempted to fill this gap with non-contributory benefits, but coverage and benefit levels are low. By contrast, formal workers have access to a full range of social protection benefits, involving large-scale public subsidies to the better-off. Labour informality and social protection coverage are interlinked, as high social contributions are one of the main barriers to formal job creation. Ensuring some basic social protection coverage for all, while simultaneously reducing the cost of formal employment, would reduce labour informality, raise productivity, and decrease poverty and inequality, all of which are long-standing challenges in Colombia.
The COVID-19 pandemic has highlighted long-standing gaps in the social protection system and is reversing decades of progress made in eradicating poverty and reducing inequality. Major structural problems, including a high share of informal workers with no social insurance and a low coverage of social assistance programmes, have worsened and become more visible with the pandemic when incomes of those at the bottom of the income distribution fell three times more than for those with higher incomes. Colombia put in place comprehensive social emergency measures that have been crucial to averting a steeper fall in incomes, particularly among the most vulnerable. These included both an expansion of existing benefits and the establishment of new ones, including an unconditional cash transfer programme and wage subsidies. These social emergency measures prevented 4 million Colombians from falling into poverty in 2020, mitigating the increase in the poverty rate by 3.6 percentage points. Still, unfortunatedly some 3.5 million Colombians fell into poverty, adding up to about 21 million (42.5% of the population).
Structural characteristics of Colombia’s labour market are, at least in part, responsible for the large impact of the pandemic on social outcomes. Nearly two out of three workers in Colombia are informal, with no access to contributory social insurance, such as unemployment insurance, old-age pensions or paid sick and maternity leave. Informal workers typically have low and more unstable incomes and lack savings, making them particularly vulnerable in crises. On the other hand, formal workers benefit from employment protection, regulated minimum wages and contributory social protection schemes. Informality also tends to keep companies inefficiently small and their productivity low (Loyaza, 2018[1]). With less access to digital solutions, informal firms have struggled to access the policy support put in place during the pandemic, such as wage subsidies and state-guaranteed loans. Widespread informality also reduces the bases for corporate and personal income taxes, which in turn limits the quantity and quality of public services and the capacity of the public sector.
Among the many roots of informality, including low access to high-quality education and training and a weak institutional framework and enforcement, the design of the social protection system is a key factor. One of the main impediments to formal job creation are the expensive mandatory social contributions and other payroll taxes that finance formal-sector benefits (IMF, 2021[2]; Meléndez et al., 2021[3]; Levy and Cruces, 2021[4]; Loyaza, 2018[1]). The sum of employers’ obligations can reach 53% of the wage for earners on the minimum wage. Because regulations are imperfectly enforced, firms regularly evade the costs of social insurance and hire salaried workers informally. Low-income or self-employed workers with earnings below the minimum wage face prohibitively high costs of formalisation and are forced to remain informal, which is reflected in the low social insurance coverage. These high non-wage costs, bundled with a relatively high minimum wage whose level is close to the median wage, leaves many workers in informal jobs.
To address the lack of coverage in social protection of informal workers, non-contributory pillars in pensions and health have been established over the years. These pillars are financed through the budget with general tax revenues, i.e. non-earmarked resources proceding from different taxes, sometimes, through formal workers’ social contributions. They have been complemented by other social assistance programmes such as conditional cash transfers, which have helped to reduce poverty. But these non-contributory pension and cash transfers programmes share two common features: a low coverage, meaning that many of those in need are left behind, and low benefit levels, which in the case of non-contributory pensions amount to only around half of the extreme poverty line, designed to reflect the cost of the necessary calorie intake for survival. In general, cash transfers and non-contributory pension schemes are only targeted to the very lowest end of the income distribution, leaving many informal and vulnerable workers unprotected. The non-contributory health system has achieved almost full coverage, but its financing encourages informality as informal workers receive the same benefits as their formal peers but free of charge. As a result, the non-contributory regime has reduced the stark gap between the formal and informal workers only to a limited extent. This became painfully obvious in 2020, when incomes at the bottom of the distribution dropped much more than those at the top.
Eradicating absolute poverty is within reach for a middle-income country like Colombia, and would lead to enormous improvements in well-being. While growth has proven the most effective driver behind falling poverty in recent decades, social protection has also played an important role, despite all the shortcomings of the current institutional setup. Building on this progress will be essential for a more inclusive and fairer recovery from the deep scars of the Covid-19 pandemic.
Effective social protection is key to protect workers against idiosyncratic shocks and old-age poverty, but also to adapt to disruptions and changes. The pandemic has been the most visible example, but the digital transformation, climate change, population ageing, migration, and natural disasters are also likely to trigger adjustment processes that will require stronger social protection. This calls for strengthening and adapting the social protection system to allow it to fulfil its key role of reducing poverty and inequality. Effective social protection lays the grounds for enabling workers and their families to access better-quality jobs. At the same time, it will allow low-income earners to invest more into their health, their human capital and that of their children, and will trigger substantial benefits for productivity and long-term growth (UNDP, 2021[5]).
The long-term goal of achieving universal formalisation and universal social protection coverage will require deep reforms to social security and social assistance schemes, coupled with adjustments to labour market policies. Reforms to lower social contributions and payroll taxes can be a powerful tool to reduce informality, as illustrated by Colombia’s 2012 reform. These reforms need to go hand-in-hand with a cautious approach to future minimum-wage adjustments, as both levers affect the cost differential between formal and informal employment.
Lowering social contributions requires developing insurance mechanisms that are not tied to formal employment and not financed by charges on formal employment. A basic level of social protection, including in pensions and unemployment insurance, should be made available to all, while a more comprehensive set of benefits can support those who can contribute more. Delinking access to social protection from worker status in the labour market is the key challenge to break the current duality in incomes and job quality and requires shifting the financing of social protection from social security contributions levied on formal labour proceeds to general budget resources, most of which come from income and consumption taxes. While these general budget resources include personal income taxes, these are economically different from social security contributions in this context, even if both are largely born by households. Personal income taxes cover all income sources, not only formal-sector labour income, and they allow progressive rate schedules including zero rates on low incomes. Unifying social assistance programmes into a single cash benefit scheme while increasing coverage and benefits and providing incentives to take up formal employment will be key to tackle poverty and raise productive inclusion. Continuous efforts to enhance labour and tax enforcement should complement improvements in formalisation incentives.
The main benefit of deep reforms would be to initiate a virtuous cycle between substantial reductions in poverty and inequality and better growth prospects. Workers in the bottom 50% of the income distribution would clearly benefit from the better formal job opportunities and take-home pay that such reforms could deliver. For current formal workers, with the exception of high incomes, the effective tax burden would not change much, as the reduced payroll taxes and social contributions would be substituted by increases in personal income taxes and possibly value-added taxes. For formal workers with relatively higher incomes, a more progressive income tax schedule would imply a higher tax burden than at present.
Financing the reforms will require raising permanent additional resources by about 1% of GDP. This estimate is an upper bound, as the increased formalisation and growth, and consequent revenue collection derived from these reforms are not taken into account. Colombia has space to do this, as tax revenues are low by international standards (see Chapter 1) and expenditure can be reallocated by discontinuing ill-targeted subsidies and less efficient social policy programmes.
In many respects, the costs will be more of a political than an economic nature. The difficulties of finding the necessary political consensus for the deep reforms discussed in this chapter should not be underestimated. The political economy of the broad overhaul of existing institutions that Colombia needs, together with the required fiscal reforms to secure additional revenues, is likely to be winded and tricky. However, the dramatic impact of the COVID-19 pandemic on social inclusion and potential growth could generate the momentum and trigger a long-overdue political debate, which the incoming administration that takes power in 2022 could foster and lead.
Finding the appropriate sequencing and prioritisation is essential for a politically viable reform agenda. Moving forward in a gradual manner could help to improve political acceptance. In this regard, a first priority should be to strengthen social assistance programmes and consolidate them into a single programme to tackle poverty. This should be financed by additional tax revenues, with changes to the basic deduction and exemptions in personal income taxes being first in line, in addition to reducing exemptions and special rates in VAT. Continuing to reduce non-wage labour costs could then be addressed in a second step, by gradually shifting more of the financing burden from social security contributions towards tax revenues. This would reduce informality and hence be beneficial for productivity, equity and public finances at the same time. A pension reform, including a universal basic pension benefit, should then follow to tackle outstanding inequalities. A gradual approach to these reforms can be instrumental, but they should be undertaken in a coordinated manner. In the past, small patches to punctual problems have often failed to take into account the broader picture, and often created new challenges.
This chapter analyses the challenges and shortcomings of the current social protection system and reviews policy options to expand coverage while boosting formal employment, which is one of the most salient policy priorities for Colombia. The benefits of reforming social protection should be potentiated by simultaneous policy action in other policy areas, including reforms to boost the structurally low and stagnant firm’ productivity and the low access to high quality education and training, as discussed in Chapter 1 and in previous Economic Surveys (OECD, 2019[6]; OECD, 2017[7]).
Poverty and inequality declined significantly in the last two decades in Colombia, but remain the highest among OECD countries (Figure 2.1). Between 2001 and 2015, poverty declined rapidly by about 22 percentage points (1.6 per year, on average), according to the national definition. The middle class also grew substantially during the same period, by around 20 percentage points to 40% of the population (De la Cruz, Manzano and Loterszpil, 2020[8]). The decline in poverty decelerated and poverty eventually started increasing again as of 2017, partly explained by lower economic growth after the strong oil shock in 2014. Economic growth was the main driver of the reduction in poverty and inequality (Joumard and Londoño Vélez, 2013[9]), and the increase of the middle class during the last decade. Beyond growth, however, new social assistance programmes and higher redistribution played an important role (Messina and Silva, 2019[10]). In-kind transfers, particularly education and healthcare services, have also contributed substantially to the reduction of inequality and poverty in the last two decades (Nuñez et al., 2020[11]; Lustig, 2016[12]). However, the redistributive impact of taxes and transfers remains relatively low compared to advanced and even other developing countries (Lustig, 2016[12]).
Note: In Panel A, poverty is defined as the share of people living in a household below the 50% of the median disposable household per capita income (or, in some cases, consumption expenditure). This poverty measure is different from the national definition of poverty by DANE, which is used in Panel C. Gini index measures the extent to which the distribution of income (or, in some cases, consumption expenditure) among individuals or households within an economy deviates from a perfectly equal distribution. Panel C shows povety using the national defition based on the calculation of the basic food consumption basket.
Source: World Bank, WDI; DANE.
The Covid-19 pandemic had a profound impact on lives and livelihoods, increasing poverty from 36% to 42.5% in 2020 (Figure 2.1, Panel C). Many of these newly poor households suffered steep income declines and 1.7 million people fell out of the middle-class (Figure 2.2). At the end of 2020, more than 70% of the population were living in poverty or at risk of falling into poverty. Inequality, as measured by the Gini coefficient, increased by 1.8 percentage points during 2020, despite a strong policy response that included a substantial expansion of existing cash transfer programmes and the creation of new ones.
Note: Poor are those individuals in households with per capita household income below the poverty line according to the national definition; the low-income class comprises individuals in households with per capita household income between the poverty line and 2 poverty lines; the middle-income class comprises individuals in households with per capita household income between 2 and 10 poverty lines, the upper-income are individuals in households with income above 10 poverty lines.
Source: OECD calculations using GEIH 2019 and 2020.
Massive losses of jobs and livelihoods have been the main drivers of the increase in poverty and inequality following the COVID-19 pandemic (Figure 2.3). This strong impact has its roots in already existing inequalities driven by a high share of informal jobs (Box 2.1), the resulting low social protection coverage and high unemployment, both concentrated in the lowest part of the income distribution (Figure 2.4). This has been coupled with a traditionally patchy coverage of cash transfers benefits that miss out many households in need, despite a significant benefit expansion of existing programmes and development of new programmes in response to COVID-19. Aware of the many challenges, the authorities commissioned in mid-2020 detailed diagnosis and analysis in the context of an “Employment Mission”, which provides useful diagnosis and recommendations to follow up on (Levy and Maldonado, 2021[13]). In addition, a temporary reduction in non-wage labour costs targeted on youths and women is meant to support these groups, which were particularly affected by the pandemic.
There is no unique definition for informal employment. However, a generally accepted way to define it is jobs that are not taxed, registered by the government or do not comply with labour regulations. The International Labour Organisation (ILO) defines informality for salaried workers as those whose employers do not contribute to social protection systems. The ILO uses a different definition for the self-employed depending on the informal nature of the business or the size of the firm (less than 5 workers). This makes both categories not comparable. This chapter defines informal employment as every type of worker not contributing to social security, i.e. the pension system. The payment of the pension contributions is highly related to all the remaining social contributions (such as health) or the non-compliance of other employment regulations.
Informal employment is highly segmented by socioeconomic characteristics (Figure 2.5, panel A). Most migrant and rural workers regularly hold informal jobs, as do young workers, self-employed and part-time workers. Low skills and informality are strongly connected, with decreasing informality as workers attain higher education levels. The agricultural sector, retail, hotels and restaurants and the construction sectors concentrate many informal workers. Poverty rates are higher among workers in informal employment and there is a strong correlation between household income and informality (Figure 2.5, panel B). Furthermore, informal workers tend to have lower (Figure 2.6) and more unstable incomes, limiting their ability to cope with income shocks. Many workers in Colombia transit between formality and informality many times during their professional careers (Meléndez et al., 2021[3]). This implies that some workers, even when they contribute for some time, usually do not fulfil the requirements to access unemployment insurance or contributory pensions.
Note: Year 2019. In panel B: poor are those individuals in households with per capita household income below the poverty line; the low-income class comprises individuals in households with per capita household income between the poverty line and 2 poverty lines; the middle-income class comprises individuals in households with per capita household income between 2 and 10 poverty lines, the upper-income are individuals in households with income of more 10 poverty lines.
Source: OECD calculations based on Households Surveys, GEIH.
Note: Kernel estimates of average monthly-equivalent labour market incomes for formal or informal workers (not contributing to the pension system) in 2019. The red vertical line represents the minimum wage in 2019.
Source: OECD calculations based on Households Surveys, GEIH.
Colombia has also high levels of business informality. Around 76% of microenterprises were not registered with the tax administration and 89% were not registered in the chamber of commerce in 2020, according to the microenterprises survey of the national statistical institute. This is highly correlated with low compliance for hiring formal workers, sanitary standards, low implementation of formal accounting and tax declaration and payment (DNP, 2019[14]). Indeed, 88% of microenterprises did not contribute to health or to pension and 95% did not contribute for professional risks. Most informal jobs are concentrated in small firms with a high incidence of low skill and low-productivity occupations (Eslava, Haltiwanger and Pinzón, 2019[15]).
Informal workers suffered the most from the economic fallout of the pandemic, as job losses among informal workers were almost twice as high as among formal workers (Figure 2.7). This marks a break with past recessions when informality used to cushion the decline in employment and acted as a countercyclical buffer. During the pandemic, the lockdowns and mobility restrictions forced many informal workers to stay at home and leave the labour force. While informal workers saw a decline in their average labour income of 6% in 2020, driven mainly by lower hours worked, average labour income increased slightly for formal workers (Figure 2.7). The latter is explained by composition effects as the adjustment in formal employment was mainly done at the expense of temporary workers (ILO, 2021[16]). Precisely because informal jobs are outside the scope of the government, stimulus policies in the form of credits, wage subsidies or furlough schemes generally missed informal workers. One exception is a programme (Unidos por Colombia) in which informal entrepreneurs could access state-guaranteed loans. Moreover, as informal workers have usually no access to savings or any type of social protection, they depended on government cash transfers that compensated only partially for their lost income (Busso et al., 2020[17]). As the economy rebounds, the recovery in employment has been led by informal jobs, threatening to have a permanent raise in informality, which would widen gaps in incomes and job quality (Maurizio, 2021[18]).
Large firms, with a high incidence of formal jobs, were able to cope without downsizing thanks to their greater assets and financial space. Many of them have been able to benefit from increased liquidity, state-guaranteed loans and wage subsidies, some of which were conditional on maintaining their payroll. In contrast, the more numerous micro and small, low-productivity, firms with high incidence of informal jobs were not able to access this liquidity support. They were also less ready for digital solutions, such as selling online or teleworking (OECD, 2019[19]).
Source: Calculations based on GEIH 2019 and 2020, DANE.
Women were also more affected by COVID-19, partly because of pre-existing large employment and wage gaps, which were amplified in 2020 (Figure 2.8, Panel A). Female labour force participation has seen an unprecenteded reduction during 2020, and as the economy rebounds, the recovery has been slower than for men. This is, at least partly, explained by school closures, which lasted for around 30 weeks in 2020, one of the longest closures in the world. Households with a female head were disproportionally affected by increases in poverty in 2020 (Figure 2.8, Panel B). The impact of the crisis also varied greatly across cities and regions, reflecting significant discrepancies in informality, availability and quality of public services.
Source: OECD calculations based on GEIH 2019 and 2020.
The migrant population has also been strongly hit by the COVID-19 pandemic as they face various vulnerabilities. Only 25% of Venezuelan migrants have a standard employment contract, and around 90% of Venezuelan workers have informal employment and lack social security coverage (Farné and Sanín, 2020[20]). Migrants were covered by the policy response to the pandemic, in particular in the cash transfers programmes. However, additional requirements, such as a minimum period of residence or being registered in the social registry of beneficiaries, led to the de-facto exclusion of many Venezuelan families.
Aware of these challenges, the Colombian authorities improved immigrants’ access to social protection in 2021 by developing an unprecedented regularisation of immigration status for Venezuelan migrants. In March 2021, Colombia announced a 10-year Temporary Protection Permit for Venezuelan migrants resident in Colombia, granting them temporary legal status. More than 2 million Venezuelans are expected to benefit from the measure, making it one of the largest regularisations ever undertaken in the OECD (OECD, 2021[21]). Access to this mechanism guarantees regular residence states including eligibility for formal employment, education, and healthcare. However, an effective integration of migrants will require a comprehensive strategy with actions spanning several policy areas, such as education, business regulations, pensions, and labour market policies to eliminate remaining integration barriers and improve access to social protection.
Ethnical minorities have also been strongly affected by the pandemic. Poverty rates were higher among those groups before the pandemic and access to social protection very low (ANDI, 2019[22]). The Government increased cash transfer support for ethnical minorities during the pandemic. However, lack of timely statistics prevents a more detail analysis of their labour market integration and access to social protection of these groups, leading to challenges for the design and implementation of public policies.
The social protection system in Colombia is fragmented with entitlements mostly determined by the labour market status (Box 2.2). On the one hand, “social security” benefits are associated with formal work, and, on the other hand, “social assistance policies” directed towards the poor constitute a parallel non-contributory system.
The result of this set-up is a segmentation of the labour force into two categories: formal workers on one hand, covered by contributory programmes and minimum wage regulations, and informal workers on the other, some of which have access to non-contributory social assistance programmes. Informal workers have lower average incomes than formal workers, however, some informal workers have incomes above the poverty line, which generally precludes them from access to non-contributory benefits. Other informal workers may simply not be covered by the social security system because the law excludes them from contributing if they earn less than a monthly minimum wage. Self-employed workers can contribute even if they earn less than the minimum wage, but their social contributions need to be based on a monthly minimum wage. This duality has led to a low coverage of social protection (Figure 2.9).
This fragmentation is not only a source of inequality, but also one important factor contributing to low productivity growth (Levy and Schady, 2013[23]; Levy and Maldonado, 2021[13]). When contributory benefits from the social security system are not fully valued by workers, they tend to act as an implicit tax for formal employment. At the same time, non-contributory benefits can act as a subsidy to informality when they are perceived as similar as those enjoyed by formal workers, who pay for them. In addition, firms tend to stay inefficiently small as they attempt to fly below the radar of labour market inspections.
Note: Vulnerable people are defined as all children plus adults not covered by contributory benefits and people above retirement age not receiving contributory benefits (pensions). LAC5 is the unweighted average of Argentina, Brazil, Chile, Costa Rica and Mexico.
Source: ILO, World Social Protection Database, based on the SSI; ILOSTAT; national source.
The social security system comprises health, pension, and unemployment insurance and occupational risk coverage (Figure 2.10). The system is financed through contributions made by employers and/or employees which are proportional to the worker’ salaries or wages, hence the label of “contributory social security scheme”. Workers covered by this system are also subject to regulations on employment protection and minimum wages.
The social assistance system was created to provide insurance to those left out from the contributory social security system and is generally financed through general taxation, hence the label of “non-contributory scheme”. It covers mainly the non-contributory (subsided) health scheme; a small non-contributory pension scheme, which is a cash transfer programme to assist the elderly poor (Colombia Mayor); conditional cash transfer programmes (such as Familias en Acción); and an integrated strategy to help people in poverty (“Estategia Unidos”). The national training institution (Servicio Nacional de Aprendizaje, SENA) offers vocational and professional training, and the Colombian Family Welfare Institute (Instituto Colombiano de Bienestar Familiar, ICBF) assist vulnerable and poor households. Other important programmes, such as Familias en su tierra (“Families on their own land”), assist the victims of forced displacement who have returned or relocated to their land to help improve their living conditions through access to food, promotion of productive initiatives and improvement of their living conditions. Other programmes targeted at the poor aim at strengthening entrepreneurship and promoting productive activities to sustain self-generating income activities.
Source: OECD Secretariat.
Coverage gaps are associated with low spending in social protection. Although social spending has increased substantially in the last two decades from 5.7% of GDP in 1990 (Melo-Becerra and Ramos-Forero, 2017[24]) to 10% of GDP in 2019, it remains low in international perspective (Figure 2.11). Spending in social protection is around 8% of GDP, but 60% of this spending is allocated to pensions, while less than 3% is allocated to social assistance programmes supporting the poor.
Moreover, targeting is poor, with a significant part of social public spending benefiting non-poor households (Table 2.1). This is especially true in the case of pensions, housing, education subsidies and public utilities, such as electricity or telecommunications. Pension spending is the most ill-targeted: 73% of subsidies go to high-income households, while only 5% goes to the poorest households. In fact, Colombia is the only country in the region in which contributory pensions increase inequality (Lustig, 2016[12]). This is driven by the high share of informal jobs that lack pension coverage. Pre-school and primary education expenditure is well targeted to the poor, but the benefits of public spending on tertiary-level education mostly accrue to high-income households (Joumard and Londoño Vélez, 2013[9]). The best-targeted items are social assistance programmes, such as Familias en Acción, and although almost 40% of spending went to non-poor households in 2016 (Fedesarollo, 2021[25]), targeting has improved recently.
Subsidies for public utilities are the second most ill-targeted item, as 80% of the public spending accrued to non-poor households. Usually, subsidies for public utilities are inefficient as they distort price signals and can result in harmful consumption decisions, such as lower incentives to save energy. A cost-benefit analysis of each subsidy for public utilities could be conducted to eliminate those that are socially and environmentally harmful. Vulnerable households can be better supported by cash transfers. If subsidies cannot be eliminated, improving their targeting would at least increase the efficiency of public spending and help those that need it the most (see section 0). For example, 90% of households receive subsidies for electricity and 60% for gas (Eslava, Revolo and Ortiz, 2020[26]).
Note: Year 2019. Social expenditure comprises cash benefits, direct in-kind provision of goods and services, and tax breaks with social purposes. In the OECD Social expenditure database Colombia shows a 13.1% of GDP in 2018 of social spending.
Source: DNP and OECD Social expenditure database.
A relatively high minimum wage raises formal salaries but exacerbates informality
The minimum wage in Colombia - at 90% of the median wage and 62% of the mean wage of full-time formal employees - is high in comparison with OECD countries (Figure 2.12). International evidence on the impact of minimum wages on employment is not conclusive (Broecke, Forti and Vandeweyer, 2017[27]). However, evidence for Colombia clearly indicates that the relatively high minimum wage has a negative effect on employment, especially for workers earning close to the minimum wage (Maloney and Nuñez, 2000[28]; Pérez Pérez, 2020[29]; Mora and Muro, 2019[30]), and induces informality (Arango, Flórez and Guerrero, 2020[31]; Mondragón-Vélez et al., 2010[32]; OCDE, 2019[33]; Arango and Flórez, 2017[34]; Olarte Delgado, 2018[35]). This high relative minimum wage is, at least in part, symptomatic of a significant fraction of workers with lower labour productivity than the minimum wage, which makes it unattractive for firms to hire them as formal employees.
Note: Exactly half of all workers have wages either below or above the median wage. Percentage of minimum to average wage 2017 for China, Indonesia and the Russian Federation.
Source: OECD, OECD Employment Outlook Database; China Ministry of Human Resources and Social Security, National Bureau of Statistics; Instituto Brasileiro de Geografia e Estatística (Pesquisa Nacional por Amostra de Domicílios); International Labour Organisation (ILO) Database on Conditions of Work and Employment Laws; Ministry of Man Power and Transmigration of the Republic of Indonesia and Statistics Indonesia (BPS); Russia Federal State Statistics Service; National Institute of Statistics and Census of Argentina.
This high minimum wage has likely left many workers in informal jobs, self-employment and unemployment. Almost half of the total workforce earns less than the minimum wage, and this number is higher for self-employed, women, informal, young, low-skilled and rural workers (Figure 2.13), whose labour productivity is likely lower. As argued in OECD (2016[36]), the high minimum wage should also be seen in the context of the limited role of collective bargaining in Colombia. Since the minimum wage is one of the few ways for trade unions to improve working conditions for their affiliates, they tend to put strong pressure on raising it. These attempts can fail to consider the effect of minimum wage increases on informal workers. At the current high level, marginal increases in the minimum wage are likely to have regressive income effects as they reduce formal employment prospects for low-skilled workers, youth and people located in rural and less developed regions (OECD, 2015[37]).
Over time, the value of the minimum wage has increased more rapidly than consumer prices and labour productivity. Between 2011 and 2019, the average annual increase in the minimum wage exceeded inflation by about 1.6 percentage points. Labour productivity grew by an annual average of 0.3% during the same period. For 2022, the minimum wage has been increased by 10%, while inflation in 2021 was 5.6%.
Colombia’s minimum wage is used as a gatekeeper for accessing the contributory social security system. Only salaried workers earning at least one minimum wage can contribute to the contributory pension system. For self-employed workers, social contributions cannot be based on a monthly income of less than the minimum wage. As a result, social security contributions amount to a significantly higher proportion of remuneration for those earning below the minimum wage than for other workers, which adds to the regressive nature of current arrangements. Allowing workers with incomes below the minimum wage to participate in social security, and calculating contributions bases on their actual incomes, would improve incentives for low-income and vulnerable workers to get a formal job and social insurance coverage.
In the context of the current crisis, which has disproportionately affected young people and low-skilled workers, future minimum wage increases should be approached with caution, evaluating both the effects on formal and informal workers, an issue that has been discussed in past Economic Surveys (OECD, 2015[37]; OECD, 2019[38]). Given the current level of the minimum wage, adjusting it only for changes in prices would be a reasonable approach for the next few years, as recommended in the past Colombia Economic Survey (OECD, 2019[39]).
In the medium term, a permanent and independent commission could provide recommendations on setting minimum wage increases, as in other OECD countries. For example, the process of setting minimum wages in Germany and the United Kingdom includes a systematic monitoring of its potential impact by specific independent bodies mandated to evaluate and provide recommendations (Low Pay Commission UK, 2018[40]; Eurofound, 2018[41]; Vacas-Soriano, 2019[42]). The Low Pay Commission in UK is formed by experts and academics, and is mandated to evaluate and advise the government on the impact of increasing the minimum wage. The commission conducts research and publishes annual reports to inform the debate on minimum wages and its impact on employment. In Colombia, such an independent commission could advise on the impact of increases of minimum wages on formal and informal workers. This advice could then feed into the decisions of the existing commission responsible for setting the minimum wage via social dialogue and negotiations.
Colombia could also consider to differentiate the minimum wage by age (OECD, 2015[37]) or by region (OECD, 2017[7]), as proposed in past Economic Surveys. These measures would particularly help formalisation in rural areas. For younger workers, a differentiated minimum wage would facilitate their entry into the labour market and reduce unemployment. While a unique national minimum wage is easier to operate, communicate and enforce, it offers less scope to take into account the particular circumstances of different age groups or regions, such as the cost of living and labour productivity.
Non-wage labour costs are high increasing informality
In addition to the high minimum wage, non-wage labour costs add 50% the labour costs of an average-wage worker (Figure 2.14). However, for informal workers, non-wage labour costs usually add up to 120% to their average wages (Alaimo et al., 2017[43]). Such high costs perpetuate a high incidence of informality, self-employment and unemployment.
Note: LAC refers to the average of 20 countries in the region. Estimations include mandatory contributions (such as social security contributions for health and pensions, professional risk, transport subsidy), 13th salary in the form of bonuses, annual leave, severance payment and firing notice.
Source: Alaimo et al. (2017), “Measuring the Cost of Salaried Labour in Latin America and the Caribbean”, IDB Technical Note N. 1291, https://publications.iadb.org/handle/11319/8430.
The 2012 tax reform that reduced payroll taxes and employer’s health contributions (Box 2.3) shows that reducing non-wage labour costs helps to reduce informality. In the aftermath of the reform, labour informality declined visibly (Figure 2.15). Available impact evaluations suggest that the reform led to a 2 to 4 percentage-point reduction in the informality rate (Kugler et al., 2017[44]; Morales and Medina, 2017[45]; Fernández and Villar, 2017[46]; Bernal et al., 2017[47]). For self-employed workers, the reform implied no changes in social contributions, explaining why the effect on increased formality was stronger among employees than self-employed workers (Figure 2.16). Formalisation increased more among workers in smaller firms, as larger firms were more impacted by the simultaneous increase in corporate taxes (Bernal et al., 2017[47]). Estimates of wage effects vary, ranging from only a small effect (Morales and Medina, 2017[45]), to a positive effect of 2.7% on average wages (Bernal et al., 2017[47]). The effects of the reform have been broad-based and long-lasting, with the manufacturing, services and agricultural sectors experiencing reduced informality rates (Garlati-Bertoldi, 2018[48]).
Note: 12-month averages. Informality is defined as the percentage of workers in employment not contributing to the pension system. The statistical definition is different from the one followed by DANE. Months from April to August 2020 are missing because of the pandemic some questions were not asked in household surveys.
Source: DANE.
Despite the 2012 tax reform, social contributions remain high (Box 2.3) and prevent particularly low-income workers from accessing formal employment. For a dependent formal worker earning the minimum wage, the cost of contributions and other payroll taxes amounts to 53% for an employer. Among the most costly items is a transport allowance, which is mandatory only for workers earning less than two minimum wages and is not considered in the calculation of social contributions. The only rationale behind this allowance is its exemption from social contributions, but it constitutes a big disincentive to formal hiring.
In December 2012, Colombia’s Congress approved a reform that reduced payroll taxes by 13 percentage points of wage earnings. In particular, it eliminated employers’ contributions to SENA (the public training agency) and ICBF (the childhood services agency), previously set at 2% and 3% of firms’ payrolls respectively. The reform also eliminated employers’ contributions to the health system set at 8.5% of the payroll. These payroll reductions applied only for workers with wages below ten minimum monthly wages (around 98% of formal workers). SENA and ICBF contributions were eliminated by mid-2013, while health contributions were eliminated starting in January 2014.
To finance this reduction of payroll taxes, authorities implemented a new corporate income tax (the “CREE”) of 9% over total profits, while reducing the existing corporate income tax from 33% to 25%. The goal of the reform was to stimulate formal employment, while keeping tax revenue unchanged. The reduction in payroll taxes did not apply to employers not subject to corporate income taxes, including e firms in the special tax regime, in particular, non-for-profit organizations, mainly in the education and health sector.
Table 2.2. shows all non-wage labour costs for employers, employees and the self-employed after the 2012 tax reform. The largest single elements of the tax wedge are pension contributions (12% for the employer), transport and severance allowances (11.7% and 8.3%, respectively) for the employer and pension and health benefits (8%) for the employee.
Vast evidence shows that these high mandatory contributions for social security can explain high informality in Colombia (Camacho, Conover and Hoyos, 2013[49]; Cuesta and Olivera, 2014[50]; Kugler, Kugler and Prada, 2017[51]; Kugler and Kugler, 2008[52]). The current high costs of formal labour also explain the large share of self-employment in Colombia, as firms usually evade social contributions when these are bundled with stringent labour regulations or high minimum wages (Levy, 2019[53]). Self-employed workers’ contributions are always calculated based on the minimum wage, even when they earn less. As a result, their social contributions are highest for those with low incomes (Figure 2.17). This acts as a particularly strong impediment to becoming formal (Meléndez et al., 2021[3]).
Source: (Meléndez et al., 2021[3])
Other non-wage labour costs are related to costly and complex business regulations that hamper the formalisation of firms and jobs. The Government has been implementing a one-stop shop mechanism for all registration procedures (Ventanilla Única Empresarial), and should keep up efforts to integrate all the commercial, tax and social security procedures necessary for the opening of companies and registering formal workers (see Chapter 1). Increasing the use of digital tools would also offer the double dividend of reducing the regulatory burden, opportunities for corruption and the scope for non-compliance. The simplication of the tax system, particularly for SMEs, can be also a powerful tool to increase business, and hence employment, formalisation. Efforts in this direction have been undertaken with the new SIMPLE tax regime that will not only reduce the tax burden but also facilitates compliance with tax obligations for micro and small firms. Authorities have also implemented programmes, such as Programa para la Formalización and Crecimiento Empresarial, aiming to formalise micro and small firms.
The pension system has low coverage and is a key driver of high inequality
The Colombian pension system is complex and coverage is low, with 45% of those aged 65 and above receiving no old-age pension at all. The pension system comprises a contributory pillar formed by a public benefit-defined system and a parallel private system based on capitalisation and defined contributions (Table 2.3). Only formal-sector workers earning at least the minimum wage can contribute to these two plans. Colombia stands out in the region as one of only two countries (with Peru) with both defined-contribution and defined-benefit schemes operating at the same time. An individual worker can only contribute to or receive benefits from one system at a time, but the coexistence of two schemes operating under different rules means that two workers with identical contribution histories can acquire different pension entitlements at retirement. Additionally, a small non-contributory pillar (Colombia Mayor) provides small cash transfers to the poorest of the elderly.
The contributory pension system adds to income inequalities mainly because of the low coverage among low-income earners (Figure 2.18, Panels A and B). Currently, 25% of Colombians in retirement age receive a contributory pension and under current requirements, less than 20% of the old-aged by 2050 are expected to access contributory pensions (Bosch et al., 2015[54]).There are marked differences across populations groups. Women have a coverage of 21%, while for men the coverage is around 30%. In rural areas, less than 10% of the elderly are covered.
The low coverage of the contributory pension system reflects the low share of workers paying contributions in the context of widespread informality. Many workers who have contributed at least at some point of their careers do not manage to get a contributory pension. An additional disincentive to contribute is that when workers get their savings back, they typically get a lower return than if they had saved in financial assets. This is driven by high commissions in the private funds and the fact that returned savings are only adjusted for inflation in the public system.
The non-contributory scheme Colombia Mayor has expanded in recent years, helping to reduce old-age poverty (DNP, 2016[55]; Econometria, 2017[56]). However, this scheme covers only 39% of those older than 65 with no contributory pensions in 2019, or 29% of the population aged 65 and above. Average benefits are low, at about 60% of the extreme poverty line or USD 25 per month, which makes Colombia Mayor one of the least generous non-contributory pension systems among emerging market economies (ILO, 2021[57]). Colombia Mayor beneficiaries are in the poorest 10% of the household income distribution and receive, on average, just 0.9% of what old-age adults in the richest 10% receive (Figure 2.18, Panel C). During 2020 and related to the pandemic, Colombia Mayor reached 1.7 million beneficiaries and the amount of the transfer was doubled. Additionally, the 2021 tax reform establishes a gradual benefit convergence with the national extreme poverty line, subject to budget availability, which would increase the budget for non-contributory pensions by 50%.
Inequities in the pension system are also driven by significant subsidies for high-income earners. In the public regime, the government fills the gap when contributions fall short of outlays, which gives rise to high implicit subsidies towards relatively high-income beneficiaries. Indeed, 51% of those with contributory pensions belongs to the 20% of the richest population (Fedesarollo, 2021[25]).The average replacement rate in the public benefit defined scheme of 73% is much higher than the 39% of the private capitalisation scheme (López and Sarmiento, 2019[58]), compared to an average 58% in the OECD. The fiscal cost of the pension system, which includes several special regimes for the public sector, military forces and teachers, is also high in relation to its coverage: 3.9% of GDP in 2019, nearly 30% of the government tax revenues, and nearly three quarters of this subsidises the public scheme.
A third pillar that encourages voluntary savings for low-income Colombians is the so-called Periodic Economic Benefits Scheme (BEPS). However, design problems and the fact that the programme relies on voluntary savings by a low-income population, who have little spare income, have limited its impact and development. Although the programme's coverage has grown, the number of people who save (around 1.6% of the old aged in 2020) and the amounts saved are low (16% of extreme poverty line).
To increase pension coverage, the government implemented a new regime in 2020 to allow workers earning less than the minimum wage to contribute to BEPS. This regime, named “social protection floor” allows part-time workers earning less than one minimum wage to access old-age pensions through BEPS instead of the contributory scheme, in addition to health coverage in the non-contributory regime and additional insurance cover against labour risks (for which the employer contributes 1% of the wage). The system is mandatory for dependent and independent workers providing services and earning less than a minimum wage. Authorities are working on a system of equivalences between the contributory and BEPS systems to allow workers to save in the two systems and transfer savings from one to the other.
Potential coverage of the mandatory social protection floor, 27% of informal workers earning less than a minimum wage in 2019, is rather limited. For the rest, the social protection floor is voluntary, notably for self-employed workers who earn less than the minimum wage. After one year of implementation, only 7000 out of 9 million potential workers have started contributing through this system (El Tiempo, 2021[59]). Adding this third element as a contributory scheme with different contribution rates and rules adds to the complexity of the pension system. It also potentially creates awkward incentives, as formal workers also need to pay the 4% contribution for healthcare once their wage reaches the minimum wage. At the same time, it does not solve the issue of inadequate pension benefits and low coverage.
1. OECD refers to the unweighted average of latest available data of its member countries excluding Australia, Israel and Switzerland.
2. Data refer to 2018 for Colombia. Latest available data for the remaining countries.
Source: Colpensiones; Finance Ministry of Brazil; MInistry of Economy of Argentina; OECD Pensions at a Glance: Latin America and the Caribbean (2014); OECD Pensions at a Glance 2019, OECD Stat Pension spending, OECD/IDB/The World Bank (2014), Pensions at a Glance: Latin America and the Caribbean and Fedesarrollo (2021).
Achieving universal pension coverage
A universal minimum pension coverage would allow Colombia to achieve significant reductions in income inequalities. Universal pension coverage could be achieved by transitioning from the current complex pension system to a simpler system with three components. A first, non-contributory universal tier would provide for all residents aged 65 and above. Benefit levels would focus on reducing old-age poverty, while leaving consumption-smoothing objectives for the other components. Beyond the obvious benefits of improving fairness and social cohesion, evidence from Bolivia shows that universal non-contributory pensions helped many households to avoid poverty during a crisis such as the pandemic (Box 2.4).
The need to strengthen the incentives for formal job creation calls for shifting the financing burden of pensions away from (formal) labour towards broader sources. Essentially, this implies financing the universal pension from general taxation revenues, as opposed to labour charges. This would generate a need for mobilising additional tax revenues, which is a key priority for Colombia. As labour charges are reduced, additional tax revenues could come principally from personal income taxes, which few Colombians currently pay and whose potential progressivity is undermined by a wide array of exemptions and special regimes, and from value-added taxes, where revenue collection is undermined by exemptions and reduced rates (see Chapter 1).
Bolivia is the only Latin American country to have established a near-universal non-contributory pension programme in 2008 (Renta Dignidad). This is the first component of a pension system that includes a mandatory scheme of individual accounts and a solidarity scheme. The programme disburses around USD 50 each month to individuals aged 60 or older, regardless of their income, and reaches around 28% of Bolivian households. Disbursements per beneficiary represent around 80% of the poverty line.
Evidence shows that this programme has significantly reduced poverty and increased income security (UDAPE, 2013[60]). During the pandemic, the programme was crucial for preventing a decline in food security, reduced financial insecurity and stress, with the greatest impacts on low-income households and those that experienced a large labour market shock. This evidence suggests that, during an economic crisis, an established, near-universal non-contributory pension programme can protect poor and vulnerable households against economic shocks (Bottan, Hoffmann and Vera-Cossio, 2021[61]).
The second component of the pension system would be a mandatory contributory scheme, financed by workers and employers’ contributions. Benefits from this scheme would top up the benefits from the first universal component. This second component should be mandatory as workers usually do not save enough for consumption smoothing over their lives. Mandatory contributory rates could be progressive, starting at zero for wage earners below and around the minimum wage and increasing gradually for higher wages. To ensure adequate pensions and fiscal sustainability, contribution rates could be calibrated to achieve replacement rates of at least 50% of pre-retirement earnings, close to the average OECD replacement rate for men (59%). Finally, a third tier of individual voluntary savings could complement the other two pillars.
This second component could be based on the current contributory pension system. But that would require a deep reform of the current contributory pension system, which is excessively complex, as analysed in a thematic chapter in the 2015 OECD Economic Assessment of Colombia (OECD, 2015[37]). This need for a comprehensive reform is also acknowledged in several reform proposals in Colombia, including by major domestic institutions such as ANIF, Colpensiones, Fedesarrollo and by Bernal, et al. (2017[62]). The track record of systems with a co-existence of parallel pay-as-you-go and capitalisation set-ups is rather weak as they add to complexity and distortions, especially when beneficiaries can arbitrage between the systems through frequent switching opportunities. If the public defined-benefit scheme continues to exist, phasing out ill-targeted subsidies and eliminating competition between the private and public schemes would be key for equity and fiscal sustainability. This would benefit from a parametric reform that links the retirement age to life expectancy and determines benefits on the basis of life-time wages instead of the last ten years of wages, as the latter leads to high implicit subsidies.
An alternative would be a defined-contribution notional-account pension scheme. This would reduce fiscal uncertainty and support financial sustainability, as it would not be vulnerable to potential imbalances arising from demographic or economic changes (Lora, 2014[63]). The accounts would be “notional” in that the balances exist only on the books of the managing institution and, upon retirement, the accumulated notional capital is converted into a stream of pension payments. Notional-accounts schemes exist in five OECD countries (Italy, Latvia, Norway, Poland and Sweden). They have proven effective in some countries for advancing reforms of pay-as-you-go systems that would face more political resistancein the more traditional terms of parametric reform of defined benefit formulas. These reform results include the use of lifetime wages for determining benefits, adjustments to reflect growing longevity and declining fertility, and incentives for older workers to remain in the labour force and pay contributions.
Maintaining the private capitalisation scheme instead would have the advantage of establishing a clear link between contributions and benefits, incentivising workers to contribute regularly. As the first component of the system is financed through general taxation, a second tier based on private capitalisation would allow to diversify funding sources, which is generally considered an advantage (OECD, 2016[64]). However, under private capitalisation schemes, workers tend to face some uncertainty about their future pensions, as these are defined at retirement and are sensitive to current capital returns.
The Chilean pension system provides an interesting model to consider (Box 2.5), as it is efficient in redistributing resources to the most vulnerable while minimising distortions on the labour market (Morales and Olate, 2021[65]). Colombia could consider a reform in which the first universal basic pension could be integrated with the individual accounts, while having public subsidies for those with low accumulated contributions to ensure a guaranteed minimum pension. Another good example from OECD countries is the Australian pension system. It has three components: a means-tested non-contributory component (“Age Pension”) that reaches 75% of the elderly; a superannuation guarantee with a compulsory employer contribution to private superannuation savings; and a voluntary superannuation contributions and other private savings (OECD, 2021[66]). Superannuation savings are encouraged through tax incentives. The Age Pension is designed to provide a safety net for those unable to save enough through their working life and to supplement the retirement savings of others. The Superannuation system, a defined contribution scheme, is not subject to financial sustainability issues and as the system reaches full maturity, fewer individuals will be reliant on the Age Pension safety-net.
Chile’s pension system has three components: a redistributive first tier, a second tier of mandatory individual accounts and a voluntary third tier. These components complement each other and act as a guaranteed minimum pension. The individual accounts system was introduced in 1981, while the redistributive tier was introduced in 2008 to expand coverage and provide a basic benefit to a larger share of the population.
In Chile, pensions are based on defined contributions, but the government provides subsidies to ensure that everyone receives a pension of at least a defined threshold, the basic solidarity pension. The basic solidarity pension is payable from the age of 65 to the poorest 60% of the population. For those without accumulated savings in the individual accounts, the minimum pension is equivalent to a third of the minimum wage (USD 150 equivalent to 60% of the poverty line). For those having at least some accumulated savings, the government provides subsidies that are decline as the pension obtained through a worker’s own resources increases in value, up to another threshold, the maximum pension with solidarity support (equivalent to USD 450 or 1.2 minimum wages). The mechanism is progressive because, even if workers have the same spells of formality during their lifetimes, low-income workers would, in absolute terms, accumulate less than high-income workers and thus receive larger subsidies (UNDP, 2021[5]). Workers never lose their contributions, and pensions increase with individual savings. The system also provides women with children with a one-time monetary transfer at retirement age.
The Chilean system suffers from low replacement rates of around 52% for men and 29% for women when including the solidarity pillar (Morales and Olate, 2021[65]). This is partly related to the relatively low total contributions during working years. The government allocated 0.7% of GDP to subsidise pensions for 1.5 million retirees in 2018. Recently, the authorities have increased the amounts of the solidarity pensions (by 50% for the basic pension and 34% for those receiving subsidies) in response to social unrest at the end of 2019. This is a first step towards improving the pension amounts of the lower-income population. The spending on pensions subsidies increased to 0.9% of GDP in 2020. A pension reform has been in discussion for a long time, increasing the contribution from employers, who currently do not contribute (only workers contribute 10% of their wages), to the individual accounts of workers. Under this proposed reform, the total contribution rate will be 16% of wages (OECD, 2021[67]).
Colombia has achieved almost universal healthcare coverage, with 97% of population covered by the public health system in 2020. This system achieves very high financial protection, with out-of-pocket expenditures below the OECD average and the lowest in the LAC region. This is a remarkable achievement and one of the highest coverage rates in the region (Figure 2.19).
However, the public health system consists of two parallel schemes, a contributory scheme for formal workers and a non-contributory scheme, incentivising informality for a number of reasons. First, the non-contributory system offers nearly the same services as the contributory one, with the exception of disability allowance and maternity leave, but is free of charge. Second, part of formal workers’ healthcare contribution is used to cross-finance the non-contributory system and thus effectively taxed away. Finally, workers face a temporary discontinuity in healthcare coverage when an individual switches between systems as a result of a change in employment status. These switches can also affect the quality of care as medical files and treatment histories are usually not shared across the two systems.
Source: OECD Health at a Glance, 2020 and (Fedesarollo, 2021[25])
Fostering formalisation without jeopardising universal health care coverage
Improving incentives to formalise while keeping good health coverage would require shifting much of the financing burden of public healthcare away from formal labour charges and towards general taxation, especially around the minimum wage where disincentives are highest.
Moving towards a single, universal health care system financed through general taxation, as opposed to social contributions paid by workers, would allow reducing by 4 percentage points the cost differential between formal and informal employment, all of which is currently paid by the employee. For self-employed workers, this would reduce the cost of formal labour by 12.5 percentage points, or even more for those earning less than a minimum wage. By not discriminating between formal and informal workers, contributing or non-contributing workers, this type of financing of the health system would boost formality (Levy, 2019[53]).
A second option that could be implemented at no fiscal cost is to unify the two systems and keep the financing through labour charges, but shift more of the burden of contributions into higher income ranges, away from the vicinity of the minimum wage. One recent proposal is to set an initial contribution rate for salaried or self-employed workers at zero if they earn up to one minimum wage or less, and increase the rate gradually up to a maximum for workers earning 25 minimum wages (Fedesarollo, 2021[25]). This would leave the average contribution rate in the contributory scheme at around 4% of wages, implying no fiscal cost, but more progressive contributions.
Health contributions generate even stronger disincentives to formal job creation in firms subject to the “special tax regimes”. This tax regime features an additional 8.5% employer health contribution, as the regime was not included in the 2012 reform due to its exemption from corporate taxes. Reducing healthcare-related labour charges and the associated distortions is particularly important in these firms, which account for 16% of all formal employment, mainly in the sectors of education and health. As these sectors provide work for 26% of female workers, reforming them would help to improve gender equality.
In addition to pension and health contributions, employers pay a 4% contribution to finance the family compensation funds (Cajas de Compensación Familiar), which offer a wide range of services from housing, education, and training programmes to sports and entertainment for affiliates. Family compensation funds have increasingly been mandated by the government to provide benefits and services to non-affiliates. Still, their financing continues to rely uniquely on formal-sector labour charges (OECD, 2016[36]). Moreover, many of the funds’ services are located in the regional capitals and are unavailable to formal employees in smaller cities or those living in the periphery. As a result, an increasing part of the contribution is in reality a tax on formal labour, used to finance social policy programmes for which formal workers are not eligible. For most formal workers, the benefits perceived fall short of the costs of the contributions, thus incentivising informality (Levy, 2019[53]).
Services currently provided by Family Compensation Funds could be subjected to a comprehensive cost-benefit and impact evaluation to determine which services offer sufficient value for money to be maintained, particularly in light of other changes in social benefits. These services could then be made available regardless of labour status and equally across the country, as the substantial variation in the quality of services offered by the different funds currently exacerbates inequalities.
As with pensions, the unintended consequences of non-wage labour charges on formal job creation call for a broader approach to raising revenues for financing general social services and benefits, including the benefits provided by Family Compensation Funds. A shift towards financing those services deemed worth maintainint through general tax revenues can subtract 4 percentage points from labour charges and significantly strengthen the incentives for formal job creation.
If this proves politically too difficult, a temporary improvement would be to transform the current flat contribution rate into a progressive rate that spares out low-income workers, for whom formalisation incentives are most relevant. A recent revenue-neutral proposal suggests a zero contribution around the minimum wage that rises with income, but remains low below two minimum wages (Fedesarollo, 2021[25]). In this case, a centralised contribution collection system would transfer resources to the funds based on the services actually provided to low-wage members and on the number of members, considering the quality of services delivered. This would be a fundamental first step towards ensuring the progressivity of the funds and strengthening the government's position on the use of resources.
Social assistance programmes have low coverage
Due to the low coverage of social insurance contributory schemes, cash transfers programmes aim at protecting those left behind by social security schemes, typically informal workers in poor households. Among poor households, 83% had all their employed members working informally in 2019. The main programmes (Table 2.4) are Familias en Acción (Families in Action), a conditional cash transfer programme to fight poverty; Jóvenes en Acción (Youth in Action), which provides incentives to young people for entering and completing higher education; and Colombia Mayor, the non-contributory pension scheme described above.
Evaluations suggests that these social programmes have contributed to reducing poverty and raising well-being of households. Familias en Acción has significant impacts on dimensions such as educational attainment, nutrition and other dimensions of life quality (Angulo, 2016[68]), in addition to reducing extreme poverty, poverty and multidimensional poverty (DNP, 2008[69]; DPS, 2020[70]). On the other hand, some evidence suggests that being a beneficiary from Familias en Acción may increase the probability of being informal, since having a job in the formal sector increases individual income and reduces the probability of being eligible (Saavedra-Caballero and Ospina Londoño, 2018[71]). Jovenes en Acción has had positive effects on earnings and employment prospects, including formality, in the short and in the long run, and increased education for participants and their relatives (Attanasio, Kugler and Meghir, 2011[72]; Attanasio et al., 2017[73]; Kugler et al., 2020[74]).
The coverage of cash transfers programmes is low, leaving many poor households without any support (Figure 2.20). 52% of poor households do not receive any support from the state. Only 13% of households with all members working informally received Familias en Acción in 2019. Insufficient programme resources are the main reason for this low coverage. In 2019, only 2.7 million families were targeted, out of 4.3 million households in poverty. The coverage is similar in rural and urban areas, but poverty is higher in rural areas, although less-educated households in remote areas are more difficult to reach. Moreover, the system lacks policies to protect the middle class from temporary shocks that may affect their income or assets.
Benefit levels of social assistance transfers are low. Familias en Acción provides financial support equivalent to less than 5% of average monthly GDP per capita in 2019 (USD 23 or 22% of the poverty line), one of the lowest in emerging markets (ILO, 2017[75]), where on average is 15% (Gentilini et al., 2021[76]).
Other social assistance programmes are designed to support productive inclusion and entrepreneurship, or to cover specific needs of certain population groups. The design of these programmes aims to cover all the life stages and the conditions necessary for a person or family to enter the labour market, self-generate income and improve their life quality. However, there is a lack of coordination of these efforts, a lack of comprehensiveness in the strategies defined to cover different risks, which reduces the efficiency of the social assistance system. Aware of these challenges, authorities set up an equity roundtable (Mesa de equidad) in 2019 formed by the president and all the ministries, to coordinate and prioritise the offer of social programmes among all institutions offering social services and the implementation of the poverty alleviation route. In 2020, the management of all cash transfers programmes was centralised under a single public entity, which is a welcome step to reduce fragmentation.
Note: in Panel B, vulnerable population is defined as (a) all children; (b) persons of working age not contributing to a social insurance scheme or receiving contributory benefits; and (c) persons above retirement age not receiving contributory benefits (pensions). Social assistance is defined as all forms of non-contributory cash transfers financed from general taxation or other sources (other than social insurance).
Source: OECD calculations using GEIH 2019 and ILO, World Social Protection Database.
The COVID-19 pandemic accelerated some important changes in social policy
In response to the pandemic, the authorities launched a comprehensive social response to protect the poor and vulnerable (Figure 2.21). Policies included a series of additional emergency cash transfers through the pre-existing programmes (Colombia Mayor, Jóvenes en Acción, and Familias en Acción) and two new programmes: Ingreso Solidario (Solidarity Income) and a VAT compensation programme. In addition, discounts on the payment of basic services have been implemented, as well as other budgetary and financial measures in order to protect household incomes. Some local governments also implemented support programmes for vulnerable households, such as Bogotá, Bucaramanga or Medellín. Spending in the social emergency programmes made through the emergency mitigation fund was stepped up by 0.8% of GDP in 2020 and 0.5% in 2021 (Ministry of Finance, 2021[77]).
Note: Extremely poor households are households with per capita household income below the extreme poverty line; poor are households with per capita household income between the extreme poverty and the poverty line; the low-income class comprises households with per capita household income between the poverty line and 2 poverty lines; the middle-income class comprises households with per capita household income between 2 and 10 poverty lines, and the upper-income are households with income of more 10 poverty lines.
Source: OECD calculations using GEIH 2019 and 2020, DANE data.
The social response was key to mitigate the impact of the COVID-19 pandemic on household incomes and poverty (Figure 2.22). By expanding the number of beneficiaries and increasing the level of benefits, social programmes supported household incomes, including for some well-off households. In particular, this support completely offset the effect of the crisis on households in rural areas, who saw their real income grow. The emergency transfers mitigated the increase in poverty nationally by 2.2 percentage points during 2020.
The main existing programmes saw benefits and coverage increase as households received extraordinary payments through existing programmes during 2020. The eligibility threshold for Familias en Acción was expanded, bringing in many households identified as economically vulnerable. Families previously excluded over failure to comply with conditions were quickly re-enrolled. The programme also temporarily waived its usual conditionality, as the lockdown made these conditions far more difficult to meet. Jóvenes en Acción widened its age coverage to reach new beneficiaries (now between 14 and 28 years old). Though this move was planned prior to the pandemic, its implementation was fast-tracked, and officials plan a further expansion that will bring in an additional 200,000 young people.
A new cash transfer programme called Ingreso Solidario was designed and implemented in record time to support informal workers. The new programme provides a non-conditional cash transfer to poor and low-income households that are not beneficiaries of pre-existing social assistance programmes. The programme assisted up to 3 million households with COL 160 thousand (USD 40, around half of the poverty line in 2020) from March 2020. The programme was designed initially for three months but then extended several times. In the fiscal reform of 2021, the authorities extended it further until end of 2022, increasing coverage to 3.6 million individuals in extreme poverty, reaching 4.1 million households. In 2022, Ingreso Solidario is expected to cost COP 7.2 trillion (around 0.6% of GDP) and to reduce poverty to pre-pandemic levels, according to Government estimates. From July 2022 onwards, eligibility criteria will be tightened as the benefit needs to consider the size and vulnerability of the household.
A key innovation of Ingreso Solidario is its use of bank accounts and mobile wallets for benefit disbursement, which helped to promote financial inclusion (Gallego et al., 2021[78]). The use of mobile wallets more than doubled during 2020 and 2.6 million beneficiaries of cash transfers received their payments through digital channels, 21% more than in 2019. Building on this progress can translate into increased opportunities for savings, access to affordable credit and other financial services for many households who, prior to the programme, were outside social safety nets and at the margins of the financial system. This would require effectively providing access to financial education to ensure that access translates into effective and safe usage.
According to early evaluations, Ingreso Solidario had positive effects on household income, food consumption and education (Gallego et al., 2021[78]). The programme increased incomes for those most affected by the pandemic, while not generating disincentives to labour market participation. It also increased households' expenditure on education and the time children dedicated to school activities.
Another new means-tested unconditional cash transfer programme, called the VAT compensation for vulnerable households, was introduced in March 2020 to make VAT less regressive. The programme was originally planned to be implemented during 2020 as a pilot for 100,000 families but with the pandemic, its rollout was accelerated and expanded to one million households. The transfer consists of COP 75 000 (USD 20 or 55% of the extreme poverty line in 2019) distributed every 5-8 weeks to beneficiaries of two existing social welfare programs benefitting low-income families and elderly: 700,000 households in Familias en Acción and 300,000 households enrolled in Colombia Mayor. Early evaluations suggest that the transfer has had positive (albeit modest) effects on household welfare measures such as financial health and access to food (Londoño-Vélez and Querubín, 2020[79]).
The COVID-19 response in Colombia marks an inflection point for Colombia and the future of cash benefits. The crisis response represents an opportunity to consolidate access and increase coverage of social programmes for the most vulnerable. However, even now the coverage of households receiving cash transfers remains low (Figure 2.23) and Ingreso Solidario covers only around 20% of informal workers (Blofield, Lustig and Trasberg, 2021[80]), leaving many unprotected.
From emergency to permanent support: a single cash benefit programme for the poor
Protection against poverty and income losses could be improved by unifying and integrating existing cash transfers into a single programme. One option would be to establish a guaranteed-minimum-income scheme for the population aged below 65, which would complement the incomes of those living in poverty. This programme could become the prime instrument for fighting poverty and provide a backstop to those who lose their livelihoods temporarily in the case of dismissal or income loss. It could be complemented by other social programmes that aim at improving household assets and human capital.
A guaranteed minimum income is a periodic cash transfer to supplement the income received by poor households to reach a certain minimum income level. Financed from general taxation revenues, such scheme could build on existing conditional and un-conditional cash transfers for the vulnerable and poor (Familias en Acción and Ingreso Solidario). The amount given to each household would be contingent on the household's own income (both from formal and informal jobs) and assets before the transfer. If the household has no income, the transfer would be made for the entire minimum income. The cash transfer would decrease gradually as household income increases, until reaching the point in which the household does not receive any transfer. Changes expected in Ingreso Solidario from July 2022 go in this direction as the amount of the benefit will consider the size and vulnerability of the household. Such benefit is different from the existing cash transfers that provide a fixed level of cash transfer to poor households independent of the household or individual income (usually called basic income schemes). It is also different from the Universal Basic Income, which grants an identical amount to every citizen, regardless of income (Box 2.6).
A universal basic income (UBI) is an unconditional cash transfer granted at regular intervals to all residents, regardless of their wealth, earnings or employment status. The main advantage of such a programme is that it is simply to implement as no conditions or requirements are applied.
The main disadvantage of an UBI is that it could be extremely costly. An unconditional payment to everyone at meaningful but fiscally realistic levels would require strong tax rises and possibly reductions in existing benefits, and would not often be an effective tool for reducing income poverty (OECD, 2017[81]). Some disadvantaged groups would lose out when existing benefits (usually all other social programmes) are replaced by a universal basic income, illustrating the downsides of social protection without any form of targeting at all.
The Universal Basic Income is fiscally unviable in Colombia and can be controversial by guaranteeing transfers to high-income earners. Setting the monetary transfer to the extreme poverty line to every household member to assure that the most basic needs of all Colombians are satisfied even if no other income is available, would have a cost of 8.7% of GDP in 2020. This UBI levels still would leave many households in poverty, especially those at old-age not receiving any pensions or the unemployed or inactive. If the transfer is set to the poverty line the cost would be 20% of GDP, almost equivalent to the tax revenues in Colombia (19.7% of GDP in 2019).
The programme would deliver unconditional cash transfers for every adult living in a poor household, in line with the Ingreso Solidario programme. When children are part of the household, the cash transfer can be conditional on human capital accumulation and desired health behaviours, as in the Familias en Acción programme, to generate incentives for investing in education and health. In line with the current Familias en Acción programme, benefit levels can take into account children’s age and educational level.
A large body of evidence suggests that unconditional cash transfers can achieve significant reductions in poverty. These cash transfers can promote credit access, better eating habits, better school attendance, better academic results, better cognitive development, reduction of domestic violence, and female empowerment (Banerjee, Niehaus and Suri, 2019[82]). Evidence on the impact of cash transfers on labour participation and formal employment are mixed. While some evidence suggests that cash transfers do not discourage - and in some cases even encourage - labour participation by beneficiaries (Banerjee et al., 2017[83]), other evidence from the region suggests that transfers can decrease incentives to participate in formal employment (Bergolo and Cruces, 2021[84]). This is usually linked to abrupt benefit withdrawals for beneficiaries who find a job or earn more, which can imply high implicit tax rates for workers who lose the transfer if they earn additional income that lifts them above the threshold stipulated in the targeting mechanism to qualify.
To maintain the incentives for (formal) work, it is important that the programme has a graduation phase, in which the value of the transfer forgone is smaller than the additional income. This is important to strengthen work incentives and graduation from the programme, as otherwise beneficiaries might be reluctant to take up work for fear of losing their benefit. The design could include a phase in which for every additional peso earned by the household or individual, only some part of the self-declared additional earnings, which includes both formal and informal earnings, are taken into account to calculate the cash benefit, until gradually reaching a point where no subsidy is available at all (Reyes, 2020[85]). Preliminary and ex-post impact assessments should be systematically conducted to evaluate the effects on (formal) labour force participation and adjust the design if necessary. Spain introduced a similar measure in 2020 with the new Minimum Subsistence Income, a guaranteed-minimum-income scheme. Adults without jobs should register with the public employment services and when they find a job, part of their wage will be temporarily exempted from the calculation of the benefit. For those adults already working, more hours worked and better jobs are encouraged, and for each extra income they earn the benefit is reduced by a smaller amount.
The level of the guaranteed minimum income should take into account at least the poverty line to ensure no household is left in poverty. By calculating the cash transfer as the difference from the per capita household income level and its distance from the poverty line, the programme would ensure that no household or individual is left in poverty. By choosing the national definition of the poverty line, the minimum income also adapts to the costs of living in the different territories and adjusts in time to changes in prices. Hence, the most efficient way to fight poverty would be to establish the minimum guaranteed income equivalent to at least the poverty line, while eliminating all other subsidies or tax exemptions. Unifying all income support in one programme would be more efficient and more transparent, which could increase support for the reform.
The programme should be accompanied by strengthening state capacities to examine the veracity of the information and provide incentives for individuals to report their income and wealth truthfully. Local networks and social assistants’ can play a key role checking the veracity of self-reported information. It is important to design incentives to encourage citizen responsibility, for example by implementing some kind of penalty for those who provide inaccurate or false information (Andes University, 2020[86]).
An almost equivalent alternative to this type of guaranteed minimum income would be a Negative Income Tax or Earned Income Tax Credit. In such as programme, the subsidy decreases gradually as the individual earns more from work, until the person eventually begins to be taxed on his or her earned income. Evidence shows that the Earned Income Tax Credit in the United States has raised labour force participation, particularly for single mothers, a group that previously faced the greatest disincentives to work (Hoynes and Patel, 2017[87]). There are also positive effects on poverty reduction, as the programme rewards work and supplements the incomes of low-wage workers. These programmes have also decreased informal employment in developing countries (Gunter, 2013[88]). The salient distinction between a guaranteed-minimum-income and the negative income tax is that in the case of the latter, its financing is done directly through a progressive income tax. Another important difference is that some part of the cash transfers can be conditional on educational and health behaviours, as proposed here. Finally, in the case of cash transfers, a network of social workers is in charge of verifying and constantly improving the database of poor households while raising awareness of available benefits. Under a negative income tax, tax inspectors do this work instead, which might make their work more difficult.
The targeting of the main social programmes can be further improved building on recent progress
Colombia has different targeting instruments for social policy. On the one hand, the Identification System of Potential Beneficiaries (Sistema de Identificación de Potenciales Beneficiarios de Programas Sociales - Sisbén) is the main targeting instrument for social programmes. Sisbén is a multi-dimensional proxy means test, implemented through a national survey of income and assets that determines if one qualifies for most social support programmes, including anti-poverty programmes and the non-contributory health regime. On the other hand, some subsidies are currently targeted based on an older instrument called the “socio-economic stratification”. This is a classification of residential properties, with the aim to mimic economic vulnerability based on the dwellings’ characteristics and their urban/rural settings, but is out to date and more than 90% of dwellings are classified as vulnerable. This is the case of the public services subsidies (energy, housing, telecommunication and water and basic sanitation), for which the targeting is poor. For example, in 2017, 81% of the residential public services subsidies and 93% of the housing subsidies went to two highest income quintiles (Table 2.1).
To improve the targeting of social spending, unifying targeting mechanisms into a single mechanism would be essential. Using Sisbén as the single targeting mechanism, merging it with updated information from the socio-economic stratification, would help to improve targeting of social policy and help those that need it the most. For example, in a welcome move, recently the authorities moved away from socio-economic stratification to Sisbén to select beneficiaries of the new programme of free tuition for tertiary education (Matrículo Cero), planned for 2023.
Sisbén has recently undergone a deep transformation improving the targeting of social policy. In 2017, the Government initiated a comprehensive census (Sisbén IV), aiming to improve the quality and timeliness of the information in the registry while making it less vulnerable to manipulation and fraud (Conpes, 2016[89]). Additionally, in 2020, the authorities implemented an ambitious process to consolidate and expand a social registry to integrate previous versions of Sisbén with the new one and other administrative databases, including the civil registry, social security, and financial sector supervisor, increasing interoperability. The social registry is geo-referenced and aims at more frequent updating of information and shorter response times for citizens by moving to a regularly-updated social registry (Conpes, 2016[89]). The fast deployment of Ingreso Solidario was made possible thanks to the development of this social registry, which allowed, for the first time, to identify low-income and vulnerable households not receiving benefits from any social programme and their contact details and bank accounts. Individuals did not need to apply for the benefits and the government contacted them individually, mainly through SMS messages. This new social registry is expected to deliver significant benefits in terms of the impact of social spending, including better targeting on the poorest and faster response times particularly in the event of shocks.
Sustained progress on this social registry, by merging additional administrative databases and increasing further interoperability among them would benefit the design and implementation of social policy. Ideally, the social information system would incorporate information on the entire life cycle of individuals from birth (with information from the civil registry), following their life path and that of their household (health, work, education and other characteristics), thereby incorporating social registries, as well as other information, such as all public-sector provision of social entitlements.
The Sisbén registry has expanded its coverage and contains information on 28 million individuals in 2021, covering almost 90% of all poor (Table 2.5). Efforts to expand coverage further aim at achieving a 98% coverage of all poor at the end of 2022. These efforts should continue to cover the whole population as it is key for providing better socioeconomic information for designing and implementing new social programmes and entitlements as well as for monitoring existing ones (Berner and Van Hemelryck, 2021[90]).
The targeting method has also been updated and takes now into account the income generating capacity of households based on their socio-economic conditions considering regional and local specificities. The current targeting method measures the structural situation of households, that is, the household long-term income level. However, to enhance the capacity to respond to crisis, it would be important to continue improving the real-time nature of the database and to develop a targeting instrument that captures short-term or sudden changes in individuals and households’ income status (Berner and Van Hemelryck, 2021[90]). For example, Brazil uses self-declared per capita household income to deliver Bolsa Familia benefits, the main cash transfer programme, and this has shown to be a good targeting instrument (WWP, 2017[91]). Another example is Chile which developed a targeting instrument for the delivery of the pandemic-related emergency measures, even if not finally implemented, based on the household income in the last month before applying to the emergency benefit. This requires fast cross-checks of income data with other data sources and high interoperability between registries to reflect immediately changes in labour market status or household income. But it would enable social policy to protect those facing income shocks even if not living in structural poverty.
Strengthening local networks and social assistants’ networks could be beneficial to make updates, search for other potential beneficiaries not yet included and check on self-reported entries in a more timely and accurate manner. Territorial entities are in charge of updating the information feeding Sisbén. However, response times, even if they have improved, are long. In other countries, means-testing mechanisms rely on granular local networks of social assistants or civil servants, for example Brazil’s CRAS. These local contact points collect timely information through regular visits and/or checks upon self-reported entries. In Costa Rica, the programme Bridge to Development (Puente al Desarrollo) involves more active participation of social workers and satellite images to increase take-up of social assistance programmes.
Implementing a universal income tax declaration and merging it with the social registry would make more reliable information on income available and allow better cross-checking of income data. Tax declarations are typically used in advanced OECD countries for the targeting of social benefits. Although many Colombians do not pay taxes, filling a tax declaration could increase awareness and help strengthen a culture of tax compliance. An example of such a system in the region is the National Tax and Social Identification System in Argentina, which coordinates tax, social, wealth and consumption data contributing to an efficient targeting for implementation and monitoring of social benefits (OECD, 2019[92]). The main function of this system is to achieve the identification of people, through the co-ordination of the exchange of the numerous databases that exist at the national, provincial and municipal levels.
This improved Sisbén could be an efficient instrument to define the amount needed to supplement each household's income up to the guaranteed-minimum-income, the new single cash benefit programme proposed in the previous subsection. All the information from Sisbén, including self-declared income, money in the financial system, household characteristics, and all available validity and cross checks of information done under this social registry would be used to determine the transfers to be done at the household level.
Risks arising from the loss of employment are covered through different instruments for formal workers in Colombia. The first is severance pay, consisting of a fixed one-off payment paid by the employer to the worker at dismissal. The amount depends on the worker’ salary, ranging between a month and a year. The second instrument is an unemployment protection scheme based on individual accounts, financed from individual savings accumulated by formal workers. Third, is an unemployment insurance benefit granted to formal workers who lose their job to partially replace the lost wages.
The individual unemployment savings account system fails to provide proper income protection to unemployed workers. In March 2021, there were around 9 million people affiliated to individual severance accounts (cesantías), corresponding to 95% of all formal salaried workers. Only 8% of all self-employed workers contribute to this system. Over the years, the system has lost its purpose of income protection in the event of unemployment as workers can withdraw the savings before job loss for a variety of reasons – for instance, to finance education, purchase a home or renovate their dwelling. In 2017, two thirds of the funds were withdrawn for reasons other than unemployment (ACRIP and Fedesarrollo, 2018[93]). To redirect the system of individual severance accounts towards income support provision in the case of unemployment, in 2013 the government introduced a bonus proportional to the savings amount for those who keep at least 10% of their savings in the fund, 25% for those who earn more than twice the minimum wage (OECD, 2016[36]).
As a complement to the individual savings accounts, an unemployment insurance (Mecanismo de protección al cesante) was established in 2013, financed through the Family Compensation Funds. This unemployment insurance is privately funded, decentralised, and has limited resources. The system ensures the continuation of health and pension contributions for six months, income-support for families with children, and provides access to public employment services and vocational training and employment offers.
Although the unemployment insurance mechanism has substantially expanded since its introduction (Figure 2.24, Panel A), most unemployed people do not qualify, as they have been informal workers or their employer did not contribute long enough. It only covers formal workers whose employer has contributed 4% of their payroll to a family compensation fund for at least 12 months in the three years before the job loss (24 months for self-employed workers). This explains the poor targeting of this protection mechanism (Figure 2.24, Panel B): 82% of resources go to non-poor households and 53% to the two highest income quintiles of households (Fedesarollo, 2021[25]).
Note: The year 2020 was an atypical year due to the pandemic and given that the resources of the 4% of the family subsidy system were exhausted, the National Government did transfers from the general budget.
Source: (Fedesarollo, 2021[25])
The unemployment insurance proved to be insufficient for compensating formal workers for income losses during the pandemic. During the lockdowns, the government implemented a transfer equivalent to two minimum wages over a period of three months for those earning less than four minimum wages. By late June 2020, nearly 800,000 applications for unemployment insurance had been received, but only 109,000 people had actually been granted insurance. By December 2020, slightly over 400,000 unemployment subsidies were approved. Given the high number of newly unemployed workers on the waiting list, the government injected the unemployment protection mechanism with resources from the general budget and authorised in early June some of these individuals to be included in a new cash transfer programme designed for vulnerable workers, Ingreso Solidario (Blofield, Lustig and Trasberg, 2021[80]).
Improving unemployment insurance
The implementation of the single cash benefit programme to the poor, discussed above, could provide a backstop for those losing their job or income and could serve as universal pillar of the unemployment insurance system. For workers earning the minimum wage, a cash benefit equivalent to the poverty line would imply a 40% replacement rate. The implementation can only be possible if the targeting system and Sisbén are made more agile and able to detect or at least verify changes in workers’ labour market status and income without long delays.
Beneficiaries would be automatically registered with the labour market intermediation services to support the search for employment and training. As part of the strategy to increase formalisation and productivity and as recommended in previous Economic Surveys of Colombia (OCDE, 2019[33]), strengthening the institutional capacity of the Public Employment Service to improve the quality of services provided and matches between job seekers and vacancies will be key. Improving quality and relevance of job training will also be essential. In Colombia, the skills gap is wide and weaknesses of the job training system affect its effectiveness to bridge this gap. Around 50% of firms consider inadequate training as a very serious constraint to their operations (Andrián and Hirs, 2020[94]). Moving towards an effective governance of the training system with a clear national regulatory framework and a clear national plan while reducing the fragmentation in the course offering would help. A national system of quality and relevance assurance using unified criteria for all suppliers would help increase transparency and quality of the system, and a first step in this direction has been taken through the National Qualifications System (OECD, 2019[6]).
The cash benefit programme designed in this way would have several benefits. Most importantly, it would allow reducing social contributions while increasing the incentives for formality and guaranteeing coverage of social insurance, mostly during unemployment, disability or maternity leave. It would also allow job seekers to look for jobs without the immediate concern for minimum survival. Doing so, the programme would increase the bargaining power of workers to obtain fair wages without relying on the minimum wage, which generates distortions against the generation of formal work.
As this pillar is designed to avoid poverty, a second contributory pillar could exist to provide consumption smoothing and maintain living standards for workers above the minimum wage. This second pillar would provide top-up benefits and be based on the existing individual unemployment accounts, financed from individual savings accumulated by workers, to achieve a replacement rate more in line with other OECD countries (60% on average).
One advantage of individual unemployment savings accounts over other unemployment insurance systems is that they significantly limit the risk of moral hazard (ILO, 2019[95]). By allowing workers to run down their personal savings during periods of unemployment, workers internalise the cost of unemployment benefits, thus strengthening the incentives of the employed to prevent job loss and of the unemployed to return to work quickly. Individual unemployment savings accounts can also strengthen incentives for working formally since social security contributions are less perceived as a tax on labour and more as a delayed payment (OECD, 2018[96]). The disadvantage of individual unemployment savings account system is that generally individuals with lower contributory capacity, who also tend to have a higher risk of unemployment, tend to receive insufficient protection. This is why these systems are often supplemented to support individuals with lower contributory capacity. The guaranteed-minimum-income programme discussed above would act as the minimum protection floor when unemployed.
The current unemployment individual accounts system would need improvements to work properly and regain its income protection role during periods of unemployment. An important first step is to restrict withdrawals to dismissals. If the worker does not entirely draw the contributions accumulated during the employment career, any surplus could be credited in the form of pension entitlements upon retirement, mimicking the current practice in Chile. In the Chilean system, workers need to fulfil certain requirements to withdraw money from the unemployment individual savings accounts system related to number of months that they have been contributing (Sehnbruch, Carranza and Prieto, 2018[97]). The contributions to the severance accounts can be limited to a certain maximum of years that would allow for a sufficient accumulation of resources to cover the eventuality of unemployment. In Chile, this maximum is 11 years.
As the benefits received from the severance accounts act providing top-ups to the guaranteed-minimum-income programme, contributions to the individual accounts can be substantially reduced. Employers are currently mandated to contribute around 8.5% of wages and 12% of interest on the annual amount of the severance pay into the employee’s severance account. These contribution rates are high even compared to advanced countries (ILO, 2019[95]). In Chile, contribution rates for a similar scheme are of 3% of wages (financed by the employer in case of a fixed term contract or 0.6% by employees and 2.4% by employers in case of a permanent contract).
An estimation of the fiscal costs and the impact on poverty and inequality
Illustrative simulations, based on microdata from a Colombian household survey (GEIH) for 2020, allow comparing costs and benefits of reforming social protection in Colombia, by estimating the likely fiscal cost of different reforms and gauging the impact on poverty and inequality. The cost estimates can only provide an upper bound for the short run, as they are based on the current status quo and do not account for the medium-term benefits from improvements in labour incomes, inequality and productivity. The latter are notoriously hard to estimate in a reliable way, but they are the ultimate reason why such a reform should be undertaken.
A basic, non-contributory, universal pension for all those aged 65 and above would cost 1.6% of GDP in 2020 (Table 2.6). The benefit would amount to a 4-fold increase vis-à-vis the current non-contributory Colombia Mayor programme and imply a replacement rate of around 50% for a minimum-wage earner. Taking into account demographics and maintaining the benefit at this level, the cost of the universal basic pension would peak at 2.6% of GDP in 2030 and fall to about 1.8% of GDP in 2060 and 0.7% of GDP by the end of the century (Fedesarollo, 2021[25]).
A guaranteed-minimum-income programme as described above, topping up all incomes of those below 65, net of current government transfers, to the poverty line would cost 4% of GDP in 2020. This number is clearly higher than the expected costs in the future, given the extraordinary increase in poverty rates during 2020. When poverty rates return to pre-pandemic levels of 2019, estimated the cost would be around 2.5% of GDP. A reasonable conservative medium-run cost estimate may be around 3% of GDP for the guaranteed-minimum-income programme (Table 2.6). An alternative option with similar fiscal cost but lower impact on social outcomes would be a basic income programme, similar to the current social programmes, delivering a fix benefit to all households in poverty regardless of their income or wealth (Box 2.7).
An alternative to a guaranteed minimum income programme is a basic income programme, similar to Ingreso Solidario and Familias en Acción. A basic income programme would deliver a cash transfer of a fixed amount for all those living in poverty. To increase coverage and benefit levels of the existing cash transfers programmes, the basic income would provide a benefit equivalent to the extreme poverty line to every household member below 65 years old living in poor households. The fiscal cost would be of 3.9% of GDP in 2020, similar to the guaranteed-minimum-income. For a similar cost, the guaranteed-minimum-income provides a higher minimum income floor, assuring no one is left in poverty. The advantage of the basic income is that is simpler to implement needing less information and less prone to errors in the amount to be delivered. However, given that Sisbén is undergoing great improvements and could easily be transformed in a real-time information database, the guaranteed-minimum-income should not be ruled out and be preferred as the impact on poverty and inequality are larger (Figure 2.25).
The impact of the universal basic pension and the guaranteed-minimum-income on poverty and inequality are large (Figure 2.25, Panels A and B). By construction, these two programmes together are lifting everyone out of poverty in the case of full benefit take-up. Benefits are clearly concentrated at the bottom of the income distribution (Figure 2.25, Panel C). This does not take into account possible inclusion errors, which in 2017 where 38% (Table 2.1). Given that Sisbén is undergoing significant improvements, the inclusion errors would be substantially lower, even if probably not zero. Inequality, measured by the Gini coefficient, would be reduced by 13 percentage points, which would leave Colombia around 7 percentage points above the OECD average of 2019. The true decline in inequality will be probability stronger as the feedback effect on labour formality is not taken into account, which would likely lead to a convergence of incomes between formal and informal workers. Furthermore, a reform would present significant scope to make the tax system more progressive, which is not yet accounted for in these estimates.
Finding alternative financing mechanisms for employee contributions to the contributory health scheme and employer’s contributions to the Family Compensation Funds would imply funding needs equivalent to 2.2% of GDP, based on 2019 household data. Workers with higher incomes, i.e. above 1.5 minimum wages, accounted for 1.4% of GDP, and for these workers, the current social contributions could be simply replaced by personal income taxes of the same amount. That would leave a remainder of around 0.8% of GDP to be financed from general taxation revenues instead of social security contributions, as workers with incomes close to the minimum wage are unlikely to become subject to personal income taxation in the near future.
These reforms together would initially cost 5.4% of GDP, but the net cost, after phasing out existing cash transfer programmes and subsidies on public services, would be lower at 3.7% of GDP (Table 2.6). This takes into account the expected savings in spending on current social assistance programmes, such as Familias en Acción, Ingreso Solidario and Colombia Mayor, whose transfers to the poor are worth 1.2% of GDP in 2020, in addition to public subsidies of around 0.5% of GDP. In the longer run, as the current pension system is replaced by a new one, current subsidies to high-income pensioners worth 2.6% of GDP would gradually converge towards zero, depending on the exact details of organising the transition in the pension reform. That would reduce the long-run net cost of a deep social protection reform to around 1% of GDP. Even in the short run, a smaller part of the pension savings could be frontloaded by subjecting high pensions from the current system to income taxes. All the calculations in this section are an illustrative exercise, with the final cost depending on many minor details of the reform and its implementation.
The implementation of such reforms can be gradual and should be accompanied by a comprehensive fiscal reform to achieve higher tax collection and redistribution (see Chapter 1). This would require a combination of reducing the many existing exemptions that dampen collection of revenues and the progressivity of the tax system; higher tax rates on high incomes; and broadening the tax bases for corporate and personal income taxes. For comparison, Colombia currently raises around 1.9% of GDP lower general government revenues than the average economy in Latin America, and 12.4% of GDP lower than the average OECD economy (see Chapter 1). The higher employment formalisation and growth driven by these reforms would also increase tax collection. Boosting the recovery with structural reforms, discussed in Chapter 1, would result in higher employment and higher incomes for individuals and, in that way, increase tax collection.
Note: The current situation includes the existing programmes, such as Colombia Mayor, Familias en Acción and Ingreso Solidario. Calculations then assume that when a new programme is introduced replaces the old existing programme. Colombia mayor is replaced by the universal basic pension programme and the rest of cash transfers programmes by the new social programme (GMI or basic income).
Source: OECD secretariat calculations based on DANE-GEIH data.
A discussion on the impact on formal employment and growth
The proposed reforms to social contributions and payroll taxes would boost formal employment permanently, due to the lower cost of formal employment relative to informal employment and capital. These reforms would induce firms of all sizes to hire more formal workers and the self-employed to become formal.
Employers’ contributions to the social security system would be significantly reduced for those with low earnings, especially for the self-employed. To gauge the magnitude of the impact on formal employment, it is interesting to make a comparison to the 2012 reform that reduced non-wage labour costs for about 13 percentage points for workers with wages up to 10 minimum wages. The reform increased by 3.5 percentage points the probability of informal or unemployed workers below 10 minimum wages moving into formality (Kugler, Kugler and Prada, 2017[51]). Hence, the semi-elasticity of formal employment with respect to each point of reduction in non-labour costs would be 0.26. Using this semi-elasticity, the estimated impact of a reduction of labour charges would be an increase of 303,000 low-income formal workers, that is 5.5% increase of all those earning less than 1.5 minimum wages.
However, these simple calculations are a lower bound, as the expected impact on formalisation is much larger for a number of reasons. First, after the 2012 reform other factors, such a fast increase of the minimum wage, counteracted the impact on formality, and the individual effects are difficult to distangle. Second, in the 2012 reform contributions of self-employed workers were not modified and estimates for this population are not available. Additionally, the reduction of non-wage labour costs, especially for the self-employed, would be much larger than in the 2012 reform, probably invalidating the use of the elasticity. Under these reforms, self-employed would only need to contribute to professional risks, making highly probable a universal formalisation, particularly for those earning less than 1.5 minimum wages. Third, contributions made by salaried workers would also be reduced (the 4% they pay to the pension system and the 4% to the health system) inducing to formality, but the impact is difficult to measure. Finally, the high labour costs are one important factor inducing informality, but there are other determinants such as the low access to quality education and training and the low productivity of firms and quality of management. Reforms on these areas would also help reduce informality and self-employment while boosting productivity.
In addition to the impact on formalisation, the reforms discussed in this chapter would increase real wages, disposable income of households and growth. First, the real disposable wage of formal employees would increase; as workers would receive part of the reduction in social contributions, at least those payed by the workers to pensions and health. Second, all elderly, except those in the transition regime, would receive the universal basic income, increasing disposable income. It is reasonable to assume that it would be entirely consumed, increasing aggregate demand. Finally, disposable income for poor households would increase as the guaranteed-minimum income implies an increase in coverage and benefits with respect to current cash transfers.
Tackling informality also requires better enforcing labour laws and taxes, especially after the substantial reduction of labour costs. The challenge for the government is to ensure that all workers, regardless of contract type, have access to adequate rights and protections, and that no abuses of the existing legislation are committed. For example, when companies falsely classify workers as self-employed or use service contracts in order to escape regulatory and tax commitments. Authorities should also step up enforcement efforts to make sure that workers, including the self-employed, and firms pay their taxes. Although Colombia has made significant efforts to reduce tax evasion, including continued improvements to the tax authority’ digital system and electronic invoicing, there remains scope for further improvements in tax administration.
An effective judiciary and well-equipped labour inspectorate is essential to avoid labour informality and subcontracting. In the past decade, Colombia has taken an impressive amount of measures to improve the labour inspection system (OECD, 2016[36]). The number of labour inspectors more than doubled between 2011 and 2019, the budget significantly increased and the fines collection system has been revised and strengthened. The government also raised salaries for labour inspectors to attract better candidates and organised a civil career exam to improve job security and limit turnover. The training offer and qualification processes for inspectors were substantially strengthened to guarantee the rights of workers and conduct labour investigations properly. Well-trained labour inspectors are key for effective enforcement. In Spain, the Labour and Social Security Inspectorate School aims to strengthen the capabilities of the Spanish Labour Inspectorate by organising training programmes and activities for all staff. By conducting research about new undeclared work trends and by providing continuous training, the school enables labour inspectors to detect and prevent undeclared work more efficiently. Collecting data, crossing different sources, such as social security, tax, healthcare, and its analysis is essential for the effective work of inspectors helping them understand which sectors or regions appear to be more problematic in terms of observance of a given law. Interventions should include not only inspection visits, but also preventive, awareness-raising and educational activities and campaigns.
Continued efforts to ensure sufficient resources to the labour inspectorate, which should count with well-trained inspectors and the capacity to collect and analyse relevant data and information, streamlining the fine collection, and improving its presence in rural areas are still needed. External oversight over labour inspectors is ensured by the public prosecutor’s office (Procuradoría), but this role could be strengthened. There has been progress and monitoring of labour formalisation agreements, increased effectiveness and progress in the collection of fines and the fight against forms of subcontracting that violate labour rights has continued (Ministerio del Trabajo, 2021[98]). However, recent information suggests that the collection of fines was already weakening before the pandemic and plummeted during 2020 (Ministerio del Trabajo, 2021[98]). There is also a need to enhance data collection for the inspectorate while assuring the skills to evaluate it in a timely manner (Levy and Maldonado, 2021[13]). Increased actions are also necessary to inform employers and workers about the benefits of formalisation and stimulate formal employment, particularly in rural areas. Providing information and technical assistance during inspections would be especially important for small and medium-sized enterprises and help them comply with regulations. Authorities have recently developed the mobile labour inspection, which purpose is to take the labour inspection system to all regions of the country. It has an emphasis on the rural areas and the territories most affected by the armed conflict, poverty, illicit economies and institutional weakness.
Finding the necessary political consensus for the very ambitious reforms discussed in this chapter will not be easy. These reforms imply overhauling the social protection system and labour market policies, accompanied by fiscal reforms to secure its financing, and the political economy of such reforms is usually complicated. The benefits of these reforms tend to be seen only gradually and over the long term, while the potential political costs of making changes that cut into the generosity of the pension system or minimum wages are immediately felt by those affected. This is compounded by the fact that the main beneficiaries of these reforms are generally vulnerable workers, young people, children and the unborn generations, while those with higher incomes in the formal labour market are the ones most affected by these changes and therefore potentially opposed.
The strong negative impact of the COVID-19 pandemic on social inclusion and potential growth could generate momentum and lead to a necessary political debate. There is an extensive literature showing there are political reasons why structural reforms, including those related to social protection, may be more often undertaken in times of economic difficulties (Sturzenegger and Tommasi, 1998[99]; Drazen and Grilli, 1993[100]).
To boost feasibility of the proposed reforms, a policy debate is essential. This policy debate should be evidence-based with clear identification of the winners and losers of the reforms, quantification of the costs and possible impact on different population groups. An analysis of the sequence and timing of the reforms will also play a very important role. Having a clear mandate and political leadership from the government showing the will and commitment to act would also be important (Tompson, 2009[101]).
An effective communication strategy on the need for the reforms and their impact on different population groups and the society in general will be essential to lead to acceptance by the population and avoid misperceptions on the impact of reforms. An effective communication strategy can include the provision of information, as well as consultation and dialogue with stakeholders. To reap its full potential, however, authorities can establish a two-way dialogue with the public (OECD, 2020[102]).
Another key aspect for the successful adoption and implementation of some of these reforms is to incorporate gradual transition mechanisms, which can reduce resistance to proposed changes (CAF, 2020[103]). This is especially the case for the pension reform. Changing dramatically the pension system requires a prolonged period of transition, in which those close to retirement and those already retired are not affected. Such people would hardly be able to make decisions in the short term that could cushion the impact that such reforms would have on their incomes. The reform recommendations in this chapter can be implemented gradually, but in a coordinated manner, applying a whole of the government approach. In the past, small patches to punctual problems have often failed to take into account the broader picture, and often created as many new challenges.
Enhancing trust in the government will also be fundamental for successfully designing, approving and implementing reforms. Mistrust of government is high in Colombia, as in much of Latin America, reducing support for tax reforms to finance education, social protection, policing and redistribution (IADB, 2018[104]). Reducing corruption and increasing transparency and government accountability, as chapter 1 in this survey highlights, would increase trust in goverment (Scartascini and Valle Luna, 2020[105]).
To optimise the implementation and ensure the fulfilment of the reform’s objectives, regular monitoring and periodic evaluation of its impact and its evolution should be implemented. A robust monitoring and evaluation framework would increase trust in the reform and support the social protection system, while offering the most productive tool to simultaneously assess the programme’s effectiveness and provide guidance for improvements. Colombia already has in place an advanced monitoring and evaluation framework implemented by Sinergia, an agency within the National Planning Department. Continuous efforts to enhance this process, stronger links between planning, budgeting and evaluation, more frequent and faster decision making linked to results, and better quality of data from the beginning of the programme implementation would help improve social policy implementation and increase feasibility of reforms.
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