Enlisting Employees in Improving Payroll-Tax Compliance: Evidence from Mexico

Investigators: CDEP Student Affiliate Todd Kumler, CDEP Co-Director Eric Verhoogen, and Judith Frías of the Instituto Mexicano del Seguro Social.

Difficulties in collecting taxes to fund public goods are a major constraint on states and economic performance in the developing world. The failure of private firms to comply with tax regulations is an important part of the general problem. This project investigates an arguably under-appreciated dimension of non-complaince: the under-reporting of wages by formal firms to avoid payroll taxes. The researchers compare information from firms’ reports to the Mexican social security agency and workers’ responses to a household survey to quantify the extent of evasion and uses the 1997 Mexican pension reform as a source of variation in the incentives of workers to make sure their wages are reported accurately. The authors have found, first, that there is substantial non-compliance; second, that compliance is greater in larger firms; and third, that the extent of evasion responded differentially to the pension reform, with evasion declining more for younger workers (who had more to gain from making sure their wages were reported accurately) than for older workers. The results suggest that tying workers’ social security benefits more closely to the wages that employers report from them can be an effective way to improve tax collection in settings with weak enforcement.

A working paper is available as CDEP-CGEG Working Paper No. 7. Listen to the audio of Prof. Verhoogen’s presentation of the paper at the 2012 IGC Growth Week Conference here (his talk begins at 47:40 in the audio file), and follow along with the slides.

This project is part of CDEP’s Firms and Innovation Initiative.