This Selected Issues paper on Argentina was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on December 1, 2017.
HOW TO REDUCE ARGENTINA’S TAX WEDGE1
1. Argentina’s average tax wedge is the highest in Latin America and is comparable to
that of OECD countries (IADB-OECD, 20162). A high tax wedge (that is, the difference between the
total cost of labor for the employer and the take-home labor income for the employee, after tax and
cash benefits) may reduce labor demand, hinders firms’ competitiveness, and act as a disincentive
towards establishing formal labor market relations, particularly for low-skilled workers. Reducing the
tax wedge is a policy priority to increase employment, support Argentina’s competitiveness, and
increase formality in the labor market.
2. However, Argentina does not have the fiscal space to cut the tax wedge for all
workers. Revenue from the Personal Income Taxes (PIT) and Social Security Contributions (SSCs),
the major components of the tax wedge, amount to about 2.6 and 7 percent of GDP respectively.3
Simply cutting SSC and PIT rates across the board would generate a revenue loss that Argentina
cannot afford, given the priority to reduce its high fiscal deficit and lack of sustainability of its
pension system, unless other taxes are raised or cuts in government spending implemented. As
discussed in the Staff Report, while there is ample room to rationalize government spending, the
space for increasing other taxes (such as VAT) is small, given Argentina’s burdensome and
distortionary tax system.
3. Against this background, this paper discusses whether there is a more efficient way of
taxing labor that has a minimal cost in terms of foregone revenues. We address the following
• What are the major distortions associated to the way labor is taxed in Argentina?
• How can labor taxation be changed to make it less distortionary and reduce the tax wedge, if
not for all, at least for most workers?
• How much would such a change cost, both directly and after considering the effect on
employment and economic activity? What would be the social impact of the reform?
4. We discuss key features of Argentina’s system of labor taxation and simulate the
impact of a possible change on the tax wedge and the macro economy. Applying (with some
simplifications) Argentina’s tax code and transfers system to individuals in the Household Survey
(EPH, Encuesta Permanente de Hogares), we estimate several measures of the tax burden on labor
(including the tax wedge) and the net cost of formalization (that is, the amount of taxes that informal
workers would need to pay, net of benefits, if they were to become formal) across the wage
distribution, for all individuals in the survey, and for a few typical categories of households. We
calibrate a simple model of optimal labor taxation (Brewer, Saez, and Shephard, 2010) to identify a
few changes to Argentina’s tax system that could reduce its distortions, while minimizing revenue
losses. Finally, we use a dynamic general equilibrium model with heterogeneous agents to simulate
the effects of the proposed changes on output, labor, and income inequality.
5. Our main conclusion is that a significant reduction of the SSC combined with an
expansion of the PIT base at the top of the income distribution would i) reduce the tax wedge
with a minimum fiscal cost, and ii) boost formal employment and output. We simulate the
effect of a package that cuts SSCs for both the employer and the employee to 10 percent (excluding
contributions for health coverage while working, or obras sociales), combined with extending the
coverage of the PIT to the top 20 percent of the wage distribution (from the current 10 percent), and
redistribution of cash transfers toward the bottom decile of the wage distribution. The aggregate tax
wedge would decline by about 9 percentage points on average, and by 20 percentage points for
individuals with wages in the first decile of the wage distributions, with a total direct fiscal cost of
0.3 percent of GDP, or 0.1 once second round effects on economic activity are account for. Formal
labor supply would increase 3.4 percent and the level of GDP by 1.2 percent in the long run, with no
adverse impact on inequality.