Encouraging informality

The Economist had a good piece on how the Mexican government is inadvertently promoting the informal sector.  One of the cornerstones of EPN’s platform was a universal social security system, which would no longer rely on payroll contributions and incentivize workers to join the formal economy.

The backlash over the new taxes implemented in the last year caused this campaign promise to be scrapped. Luis Videgaray, the finance minister, promises no new taxes until 2017.

What surprised me though was how much the government is currently subsidizing informality.  The article explains:

“The heart of the problem is the way social-security provision and labour laws have evolved in Mexico. Formal-sector workers contribute to their pensions, health care, child care and the like through payroll taxes that add an extra 30% or so to wage costs. Yet as democracy has come to Mexico, governments have added a parallel system of non-contributory pensions, health and child care for informal workers, paid out of general government revenues.

The gap in quality between the two systems is narrowing. After employee and employer contributions totalling 6.5% of salary for 24 years, a low-paid formal worker might get a pension of 1,700 pesos ($132) a month at 65. Under a law close to approval by Congress, an informal worker under 50 can expect a pension at 65 of at least 1,050 pesos a month, gratis. Meanwhile, firms are discouraged from hiring formal workers by rigid and expensive rules for severance pay.”

It’s not that surprising that informality is such a huge portion of the Mexican economy with perverse incentives like that!