Cross‐Subsidies, and the Elasticity of Informality to Social Expenditures: The Case of Mexico's Seguro Popular

Abstract

How is the size of the informal sector affected when the distribution of social expenditures across formal and informal workers changes? How is it affected when the tax rate changes along with the generosity of these transfers? In our search model, taxes are levied on formal-sector workers as a proportion of their wage. Transfers, in contrast, are lump-sum and are received by both formal and informal workers. This implies that high-wage formal workers subsidize low-wage formal workers as well as informal workers. We calibrate the model to Mexico and perform counterfactuals. We find that the size of the informal sector is quite inelastic to changes in taxes and transfers. This is due to the presence of search frictions and to the cross-subsidy in our model: for low-wage formal jobs, a tax increase is roughly offset by an increase in benefits, leaving the unemployed approximately indifferent. Our results are consistent with the empirical evidence on the recent introduction of the "Seguro Popular" healthcare program.JEL Codes: E26, J46, O17

Does informality facilitate inflation stability?

“…12 The elasticity of substitution between formal and informal goods is consistent with the value used in Restrepo-Echavarria (2014) and Fernández and Meza (2015). We also set the payroll tax ⌧ to 0.25, following the estimates in Leal (2014) and Alonso-Ortiz and Leal (2016). The parameters for nominal rigidities and the Taylor rule correspond to the prototype New Keynesian model and lie in the same range as Castillo and Montoro (2010) or Colombo et al (2018).…”

Informality, labor regulation, and the business cycle

“…The exogenous separation rate s corresponds to a quarterly exit rate from the formal sector 18 We also set the payroll tax τ to 0.25, consistent with the estimates in Leal (2014) and Alonso-Ortiz and Leal (2017), and a persistence ρ A of the exogenous technology shock equal to the observed persistence of GDP (see first row of Table 2).…”

“…However, the informality rate is counter-cyclical in both samples. Alonso-Ortiz andLeal (2017) andAlcaraz et al (2015) also show that the informality rate is counter-cyclical and, in particular, increased during the 2008-2009's Great Recession. In Appendix A we show that the counter-cyclicality of the informality rate does not seem to be driven by composition changes in the employed population across some selected demographic variables.9 In Table7from Appendix C we provide the same statistics computed using an older sample(1987)(1988)(1989)(1990)(1991)(1992)(1993)(1994)(1995)(1996)(1997)(1998)(1999)(2000)(2001)(2002)(2003)(2004) from the former Encuesta Nacional de Empleo Urbano (ENEU).…”

Informal Labor Markets in Times of Pandemic: Evidence for Latin America and Policy Options

“…The exogenous separation rate s corresponds to a quarterly exit rate from the formal sector of 8.6 percent. We also set the payroll tax τ to 0.25, consistent with the estimates in Leal (2014) and Alonso-Ortiz and Leal (2017). Finally, we set the persistence parameters ρ A and ρ i equal to the observed persistence of GDP and the foreign real interest rate, constructed as in Leyva and Urrutia (2020a), adding the Global EMBI spread for Mexico to the 90-day Treasury Bill rate and subtracting the U.S. GDP annual inflation.…”

“…(2016) for a discussion around the origins of this episode. 11 This is in contrast to the reallocation hypothesis put forward byAlcaraz et al (2015),Fernández and Meza (2015), and Alonso-Ortiz andLeal (2017) Bosch and Maloney (2008),. as we do, cast doubt on this hypothesis.12 In Brazil, unemployment claimed a more prominent role in the labor market dynamics during 2014-16, which may be partly due to unemployment insurance.…”