Poverty and Exclusion in the Western Balkans by Caterina Ruggeri Laderchi & Sara Savastano

Author:Caterina Ruggeri Laderchi & Sara Savastano
Language: eng
Format: epub
Publisher: Springer New York, New York, NY

Fig. 9.6The tax wedge, the marginal effective tax rate (METR), and the formalization tax rate (FTR) for a one-earner couple with two children in Serbia (2009). Source: Author’s calculations based on OECD tax and benefit model

The tax wedge and the withdrawal of social benefits are the main contributors to opportunity costs of formal work. Think of an informal worker who earns a certain level of informal wage.5 If this worker were to work in the formal sector, various implicit opportunity costs occur: First, assuming that the value of the marginal labor product does not change because of formalization, total labor costs of the informal worker have to be the same as for the formalized worker. For the informal worker, total labor costs are the informal wage. For the formalized worker, total labor costs are the net wage plus the income tax and both the worker’s and the employer’s social security contributions—in other words, the net wage plus the entire tax wedge. Comparing the informal wage with the worker’s potential formal net wage, the entire tax wedge enters as an opportunity cost of formal work for the informal worker. Second, informal workers also face implicit opportunity costs because they might lose parts of certain income-tested benefits—most importantly social assistance and family benefits—once they have a formal income on record. For example, if an informal worker receives a certain amount of social assistance, this benefit will be decreased or completely withdrawn if the worker formalizes and has an official income on record. This amount of the withdrawn benefit also enters as an opportunity cost of formal work.

Therefore, both of these losses—the tax wedge and withdrawn benefits—have to be taken into account when considering the implicit opportunity costs of formalization. At the same time, though, informal workers also gain from formalization: They gain a future right to an old-age pension, and they gain rights with regard to disability insurance, workers compensation, health insurance, and unemployment insurance.

Arguably, the most important of these potential gains are old-age pension and health insurance. With regard to old-age pensions, though, one has to keep in mind that especially low-wage earners tend to strongly discount future benefits because their concerns are focused on short-term income and, in cases of poverty, day-to-day consumption. With regard to health insurance, one has to keep in mind that the value of contributing to health insurance is considerably diminished because coverage is relatively easy to obtain for free. Many people are coinsured for free because their spouses might work in the formal sector. Yet, more importantly, for all those who have a monthly income below RSD 16,000 per month, health insurance is free. Since informal workers have no official income on record, it is therefore relatively easy for them to obtain free health insurance. They are required, though, to register as unemployed with the National Employment Service (NES), which creates ­additional problems further discussed below.

The implicit costs of formalization for informal workers are therefore a measurement of the necessary minimum value of social security benefits they receive in return for formalization.

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