San José, Costa Rica, since 1956

Informal workers: It’s the payroll taxes!

From the print edition

It’s well known that Costa Rica is a dual economy. Its dynamic dollar-oriented export sector alongside a domestic, traditional colón sector produces a mixed performance. 

Part of the problem for the colón economy is “informality” – small business owners who earn a living without incorporation and do not register for social security payroll taxes or declare income taxes. These types of workers are not all poor: They range from domestic servants, street vendors and handymen, to high-level professionals who prefer to avoid Costa Rican Social Security System (Caja) deductions and income tax. 

Workers can be in both markets. A doctor may have a salaried job at a Caja or private clinic, on which he and his employer pay full taxes, and do surgeries or other private treatments on an informal, tax-free basis.

How many people are part of the informal economy? Since these workers go out of their way to avoid listing for Caja and other taxes, their number must be estimated indirectly, by subtracting formal workers registered at the Caja from the total workforce. 

The chart above is based on Caja data for health- and pension-insured workers, compiled by the Costa Rican Chamber of Commerce, and on working-age population numbers from the Costa Rican Census Bureau. Caja payroll headcount numbers are much harder than fuzzy census estimates, but even so, an unexpected result stands out clearly: In the private sector, informal workers seem to outnumber formal workers. Why is this?

The Caja payroll tax for companies is 15 percent (health insurance plus pensions). The Caja also charges workers 9 percent for both types of coverage. So, for formal workers, Caja taxes payrolls at a 24 percent rate. Independent workers pay according to a sliding scale based on their income, which starts at 3.75 percent and tops out at 11 percent for monthly incomes of ₡2.2 million ($4,400).

Needless to say, since this tax is based on income and not profits, few independent workers with decent income levels sign up for Caja taxes, and those who do tend to declare incomes below their real earnings so as to be taxed at the lower end of the scale. 

In 2011, the Caja budget, based on payroll and independent worker taxes, came to 8 percent of Costa Rican gross domestic product.

This 8 percent for the Caja is on top of the 22 percent of GDP for the national government budget, based principally on import and income taxes, now under discussion in the Legislative Assembly. 

Caja payroll taxes are not only high, but also regressive, hitting smaller businesses hardest. Many small entrepreneurs and modest businesses can’t afford Caja taxes, and are forced into the informal sector to survive. 

Despite this depressing reality, there is a silver lining that, even though informal workers outnumber formal workers in the private sector, there is a favorable trend of increasing formalization. Between 2005 and 2011, the percentage of informal workers declined from 53 percent to 45 percent of the workforce, while formal private sector workers increased from 35 percent to 41 percent. 

Almost 200,000 workers got health insurance coverage and a Caja pension plan during those years, while the number of informal, uninsured workers declined slightly, from 940,000 to 912,000. 

Costa Rica’s good recent economic run has clearly benefited workers. Still, Caja payroll taxes are so high that a bigger-than-we-would-like informal sector will always be a part of Costa Rican labor reality.

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