Work and tax evasion incentive effects of social insurance programs : evidence from an employment based benefit extension

Abstract

The impact of the tax and benefit system on work incentives is one of the most salient policy issues in labor and public economics. Despite a concurrent ample literature on tax evasion, there is relatively little analysis of the joint work and evasion incentive effects introduced by social insurance and related programs. This paper evaluates the behavioral responses of workers in these dimensions. Using a quasi-experimental approach, it studies a large scale expansion of employment based benefits in the social insurance system of a middle income country, Uruguay. The policy change extended the coverage of a compulsory, in-work and payroll tax financed health insurance program to the dependent children of private sector salaried workers, but only to full-time registered employees – those complying with payroll tax and social security contribution requirements. The results indicate that individuals that benefited from the reform responded to these financial incentives as predicted by economic theory, significantly increasing their labor force participation and hours of work, with most of the increase in registered (or “on”-the-books) employment. The reform only required one registered employee within the household to warrant the extended coverage, and the results provide evidence on disincentives for secondary workers, which reduced their labor supply in the form of registered employment. The analysis also uncovers complex patterns of tax evasion responses besides the reduction in off-the-books employment (a fall in outright tax evasion). Exploiting a unique feature of the data, the results indicate an adjustment along the intensive margin of evasion, with an increase in the underreporting of salaried earnings for registered employees following the reform. The conclusion illustrates how the consideration of these additional margins that are not contemplated by the canonical model has relevant policy consequences.