- Overview
- Concept of Informal Sector
- Measuring the size of Informal Sector
- Self-Employment and Business Development
- Labor Market and Tax Regulations
- Coping Strategies and Exclusion
- Corruption and Governance
- Country Specific Information | | Labor Market and Tax Regulations
High social security contributions and excessive labor market regulations such as the payment of minimum wages as well as high tax burden are often cited as one of the two main reason (the other being corruption and poor governance) that pushes businesses in the informal sector. Very homogenous before the transition, the taxes and regulations have became considerably different across the region during the transition period.
Social Security Contributions
Excessive level of social security contributions provide incentives to workers and firms to operate in the informal sector in order to evade these payments. If firms can shift the burden of social taxes to their employees, workers have incentives to move to the informal sector. Worker’s propensity to evade payments depends on how tight he/she perceives the link between these taxes and his/her social security current and future benefits regarding health insurance, old-age income security, etc.
In some transition countries, especially in the Former Soviet Union Countries (except Baltic countries), the link between social taxes and social security benefits is very loose. The serious worsening of the health care system has reduced workers' expectations of getting good health services and coverage from the public sector. Moreover, recurrent fiscal problems have prevented social funds to protect benefits from inflation, current benefits are low and sometimes not paid at all for long periods of time. Workers are likely to be skeptical about the future of the overall system and perceive social contributions only as taxes.
Current level of social contributions in transition economies:
Minimum Wages
Too high minimum wages when enforced might drive firms into the informal sector. By making labor more expensive, high minimum wage pushes firms, particularly those who hire low-skilled workers, either to increase their capital-labor ratio and reduce their demand for labor, or to shift to the informal sector in which wages are not regulated.
Minimum wages are in place in virtually all transition economies. The minimum wage plays, however, a very different role in the Central European and Baltic Countries than in the Former Soviet Union Countries (except Baltic countries). Minimum wages in the Eastern Europe countries are set around 30 to 40% of the average wage, although there is some empirical evidence of much lower wages of unskilled workers in Poland and in the Slovak Republic. In contrast, minimum wages in most of the Former Soviet Union Countries (except Baltic countries) have fallen below subsistence levels and represent a negligible share of the average wage. In these countries, minimum wage policies have an insignificant influence on the size of the informal sector. Table 1 below presents the level of minimum wages in transition countries.
Labor Market and Tax Regulations
Although labor codes in transition countries may include an impressive array of clauses aimed at protecting workers, many of them are in fact not effective because of the government limited enforcement capabilities. In practice, the degree of labor market rigidity depends on how labor market regulations are implemented and enforced. Observers usually focus on the level of the minimum wages, and the mandated or social security benefits, such as old-age pension, health insurance or maternity leave. Mandated job security and high firing costs, government regulation of working time, fixed-term contracts, employee representation and protection also have significant influence on the labor market. Moreover, large and powerful trade unions or large share of government employees in the labor force are possible additional sources of labor market distortions.
In their paper “Labor Market Rigidity and the Success of Economic Reforms across More than 100 Countries” A. Forteza and M. Rama (2000) present aggregate indicators of labor market rigidities for a large range of developing countries over the period 1970-1999.
Following S. Nickell methodology used for OECD countries (presented in The Journal of Economic Perspectives, vol. 11, Issue 3, Summer 1997), A. Revenga and C. Sanchez in Poverty Analysis of Slovakia (forthcoming) use indicators reflecting the role of unions and the impact of payroll taxes on labor markets in some EU accession countries. Their analysis takes into account the tax burden which is reflected through a synthetic indicator that summarizes the relative level of VAT, personal income taxes and corporate taxes in each country (see Table 2).
Table 2
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