Paula Garda
Jens Matthias Arnold
Expanding Social Protection and Addressing Informality in Latin America
This chapter builds on an original background report prepared by Olga Fuentes for the OECD submitted in October 2022. The current version has been substantially revised, edited and expanded by Aida Caldera and Paula Garda, incorporating additional analysis and updates.
Abstract
The pandemic has highlighted significant gaps in social protection, in particularly among informal workers. With around 60% of workers in informal jobs, many of those most in need of social protection are left behind. The government has attempted to fill this gap with non-contributory benefits, but coverage and benefit levels are low. By contrast, formal workers have access to a full range of social protection benefits, involving large-scale public subsidies to the better-off. Labour informality and social protection coverage are interlinked, as high social contributions are one of the main barriers to formal job creation. Ensuring some basic social protection coverage for all, while simultaneously reducing the cost of formal employment, would reduce labour informality, raise productivity, and decrease poverty and inequality, all of which are long-standing challenges in Colombia.
Around 60% of workers in Colombia are informal1, lacking access to contributory social insurance, such as unemployment insurance, old-age pensions or paid sick and maternity leave. This situation exacerbates poverty and leaves many workers vulnerable to economic shocks. Informality is also high among firms, with around 76% of microenterprises not registered with the tax administration and 89% not registered in the chamber of commerce in 2020, according to the microenterprises survey of the national statistical institute. Informal firms generally face reduced access to credit and training programs, which hampers their growth, face lower productivity and lack of formal sector benefits. At the same time, workers in informal firms often lack social or employment protection and training.
As with many countries in the region, informality, a structural characteristic of Colombia’s labour market is, at least in part, responsible for the large social impact of the COVID-19 pandemic and drives high poverty and inequalities. Informal workers lost jobs at nearly double the rate of formal ones and missed out most stimulus policies, such as guaranteed-state loans, wage subsidies and furlough schemes. Informal firms also fared worse, unable to access policy support or adopt digital solutions like teleworking or online sales.
Although informality has many causes, such as the low access to quality of education and training, weak institutional frameworks and labour law and tax enforcement, the design of the social protection system is a key factor in determining informality. One of the main impediments to formal job creation is the high mandatory social contributions and other payroll taxes that finance formal-sector benefits (IMF, 2021[1]; Meléndez et al., 2021[2]; Levy and Cruces, 2021[3]; Loyaza, 2018[4]). In Colombia, the sum of employers’ obligations can reach 53% of wages for earners on the minimum wage. Because regulations are imperfectly enforced, firms regularly evade the costs of social insurance and hire salaried workers informally. Low-income or self-employed workers with earnings below the minimum wage face prohibitively high costs of formalisation and are forced to remain informal, which is reflected in low social insurance coverage. High non-wage costs, bundled with a relatively high minimum wage, which lands close to the median wage, leave many workers in informal jobs and without social protection.
To address the lack of coverage in social protection of informal workers, non-contributory pensions and health pillars have been established over the years. They are financed through the budget with general tax revenues, i.e. non-earmarked resources coming from different taxes. They have been complemented by other social assistance programmes, such as conditional cash transfers, which have helped to reduce poverty. Recent reforms, such as the pension reform in 2024, have expanded coverage of non-contributory and semi-contributory pensions and cash transfers (Box 7.1). However, non-contributory coverage and benefits are still low. The non-contributory health system has achieved almost full coverage, but its financing encourages informality as informal workers receive the same benefits as their formal peers but free of charge.
Pension reform: The pension reform approved by Congress in June 2024 aims at expanding pension coverage and addressing competition between the two competing schemes in the contributory system. Originally set for implementation in July 2025, Colombia’s pension reform is now on hold following a Constitutional Court ruling, and a new implementation date will be defined. The existing system allows members to choose between a state-run defined benefit plan, and an individual defined contributions savings account plan, managed by private pension funds.The reform establishes three benefit pillars with an additional fourth voluntary pillar, as follows:
Solidarity pillar: The non-contributory pillar is strengthened, offering eligibility to poor and vulnerable individuals aged 65 (60) or older for men (women) with minimal to no accrued pension benefits. They will receive a monthly benefit of the “extreme poverty line”, currently estimated at COP 230,000 per month (EUR 53) nearly three times higher than the existing benefit level.
Semi-contributory pensions: Individuals between 300 to 1,000 weeks of contributions but lacking the requisite of 1,300 weeks at age 65 for men or 1,000 weeks and 60 for women will receive a life annuity based on individual contributions and a state subsidy equivalent to 30% of savings for women and 20% for men. This pillar also includes workers who contribute to the scheme BEPS who may now include these contributions in the calculation of their life annuity.
Contributory pensions: Employees would contribute to the public pay-as-you-go scheme on earnings up to 2.3 times the monthly minimum wage and on earnings above this threshold to individual defined contribution accounts managed by private pension funds. Upon retirement, benefits from both sources would be combined into a single pension. A new public savings fund will accumulate the capital redirected from private funds and contributions to the public scheme. The normal retirement age (62 for men/57 for women) and most existing eligibility requirements remain unchanged, such as the required 1,300 weeks of contributions for men and 1,000 for women. However, women with children will have shorter contribution periods, with required weeks reduced by 50 per child. Indigenous peoples, Afro-descendants, Palenqueras, and peasants have also lower required contributory weeks. Employer and employee contribution rates on earnings up to four times the monthly minimum wage will remain at 12% for employers and 4% for employees, but for earnings above 4 minimium wages, the employee contribution will increase to between 1.5% and 3% (depending on the wage) to fund the solidarity pension. At retirement age, individuals with more than 1,000 weeks of contributions but less than the 1,300 weeks required for a contributory pension will qualify for an early old-age benefit equivalent to at least one minimum monthly wage, and the value equivalent to the missing contributions shall be deducted from their monthly allowance, until they attain 1,300 weeks. The reform introduces weekly pension contributions for self-employed and part-time workers. The transition system was set up with a requirement of less than 750 weeks for women and 900 for men.
Citizen Income Programme (Renta Ciudadana): A new comprehensive conditional cash transfer programme that aims to consolidate all existing programmes (Familias en Acción, Jovenes en Acción, Ingreso Solidario) while enhancing coverage and benefits with the goal of progressively reaching all households in poverty or vulnerability is being implemented. The programme maintains conditionalities of cash transfers to achieve desired outcomes in education and health. By 2024, it is set to include all those facing extreme poverty.
Achieving the long-term goal of universal formalisation and universal social protection coverage will require deep reforms to social security and social assistance schemes, coupled with adjustments to labour market policies, as discussed in chapter 1 of this book. This will require delinking access to social protection from worker status in the labour market; a key challenge to break the current duality in incomes and job quality. Lowering social contributions, particularly for low income workers, and other payroll taxes can be a powerful tool to reduce informality, as illustrated by Colombia’s 2012 reform. These reforms need to go hand-in-hand with a cautious approach to future minimum-wage adjustments, as both levers affect the cost differential between formal and informal employment. Continuous efforts to enhance labour and tax enforcement should complement improvements in formalisation incentives. Simplifying regulations, reducing bureaucratic hurdles for starting firms and reducing corporate tax burden are also critical to encouraging firm formalisation (OECD, 2024[5]).
Social protection in Colombia can generally be divided into two components: social security and social assistance. The social security component comprises a health system, a pension system, unemployment insurance, occupational risk coverage, and family benefits (Figure 7.1), and is financed primarily through contributions made by employers and/or employees proportional to worker’ wages. Workers covered by this scheme are subject to regulations on employment protection and minimum wages. The social assistance component, designed to cover those left out of the social security system, comprises the non-contributory (subsided) health scheme; a non-contributory pension scheme, which is a cash transfer programme to assist the elderly poor (Colombia Mayor before the pension reform); conditional cash transfer programmes (such as Familias en Acción, and more recently Renta Ciudadana); and an integrated strategy to help people in poverty. Social assistance is financed primarily through general taxation. Other social protection programmes to support low-income workers include the national training institution (Servicio Nacional de Aprendizaje, SENA), which offers vocational and professional training, the Colombian Family Welfare Institute (Instituto Colombiano de Bienestar Familiar, ICBF), which assists vulnerable and poor households, and Familias en su tierra (“Families on their own land”), which assists the victims of forced displacement who have returned or relocated to their land. Still other programmes targeted at the poor aim to strengthen entrepreneurship and promote productive activities to sustain self-generating income activities. Cajas de Compensación Familiar (Family Compensation Funds) in Colombia are institutions that administer a range of social benefits, including education and training, housing, unemployment support, recreation, and financial services. These funds primarily provide benefits to affiliated workers and their families. The financing of these benefits comes from social security contributions made by employers, along with parafiscal contributions.
The social protection system in Colombia is fragmented, with parallel but separate systems for formal workers (covered by contributory social insurance programs) and informal workers (covered by non-contributory social assistance programs). As discussed in Chapter 1 of this book, fragmentation of social protection systems leads to inefficiencies and coverage gaps, particularly for informal workers. While informal workers have lower average incomes than formal workers, some have incomes above the poverty line, which precludes them from accessing non-contributory benefits. Other informal workers may not be covered by contributory benefits because contributions are calculated based on a monthly minimum wage, meaning that those earning less than minimum wage would need to contribute a prohibitively high proportion of their wages to gain access. These gaps and inefficiencies contribute to inequality and low productivity growth (Levy and Schady, 2013[6]; Levy and Maldonado, 2021[7]).
Coverage gaps are also associated with low spending on social protection systems (Figure 7.2). Although social spending increased substantially in the last two decades, from 5.7% of GDP in 1990 (Melo-Becerra and Ramos-Forero, 2017[8]) to 10% of GDP in 2019, it remains low compared to other OECD countries. Spending on social protection (the primarily component of social spending) was around just 8% of GDP in 2019, with 60% allocated to pensions, and less than 3% to social assistance programmes supporting the poor.
Source: OECD Secretariat.
Another factor contributing to low coverage is poor targeting of social spending (Table 7.1). Significant shares of spending benefits non-poor households, particularly when it comes to pensions, housing, education subsidies, and public utilities, such as electricity or telecommunications. Pre-school and primary education expenditure is well targeted to the poor, but the benefits of public spending on tertiary-level education mostly accrue to high-income households (Joumard and Londoño Vélez, 2013[9]).
Note: Year 2019. Social expenditure comprises cash benefits, direct in-kind provision of goods and services, and tax breaks with social purposes. In the OECD Social expenditure database Colombia shows a 13.1% of GDP in 2018 of social spending.
Source: DNP and OECD Social expenditure database.
Social assistance programmes, such as Familias en Acción which has been replaced by Renta Ciudadana, are best at targeting vulnerable households, but still almost 40% of the spending in these programmes went to non-poor households in 2016 (Fedesarollo, 2021[10]), though targeting has improved since following pandemic-related changes and the replacement of several programmes under the 2022–2026 National Development Plan.
Note: Year 2017. Poor households are defined according to the national poverty line. The value reported for pensions in the table reflects only the implicit subsidy. Education covers all public education institutions, while education grants refers to educational subsidies and scholarships. Public services includes subsidies for public utilities such as energy, water, sewerage and communications.
Source: (Fedesarollo, 2021[10]) based on ENPH-DANE.
Non-wage labour costs, which represent 50% of the labour costs of an average-wage worker, also perpetuate high rates of informality, self-employment and unemployment (Figure 7.3). For informal workers, non-wage labour costs add up to about 120% of their average wages (Alaimo et al., 2017[11]). Among self-employed workers, contributions are highest for those with the lowest incomes, as contributions of the self-employed are always calculated based on the minimum wage, even when they earn less (Figure 7.4).
Average non-wage cost of salaried workers as % of the average net formal wages, 2014
Note: LAC refers to the average of 20 countries in the region. Estimations include mandatory contributions (such as social security contributions for health and pensions, professional risk, transport subsidy), 13th salary in the form of bonuses, annual leave, severance payment and firing notice.
Source: Alaimo et al. (2017), “Measuring the Cost of Salaried Labour in Latin America and the Caribbean”, IDB Technical Note N. 1291, https://publications.iadb.org/handle/11319/8430.
Pension and health contributions relative to the self-employed worker’s income
Source: (Meléndez et al., 2021[2])
The 2012 tax reform that reduced payroll taxes and employer’s health contributions (Box 7.2) shows that reducing non-wage labour costs helps to reduce informality. In the aftermath of the reform, labour informality declined visibly (Figure 7.5). Impact evaluations suggest that the reform led to a 2 to 4 percentage-point reduction in the informality rate (Kugler et al., 2017[12]; Morales and Medina, 2017[13]; Fernández and Villar, 2017[14]; Bernal et al., 2017[15]). Formalisation increased more among workers in smaller firms, as larger firms were more impacted by the simultaneous increase in corporate taxes (Bernal et al., 2017[15]). Estimates of wage effects of the reform vary, ranging from only a small effect (Morales and Medina, 2017[13]), to a positive effect of 2.7% of average wages (Bernal et al., 2017[15]). Overall, the effects of the reform have been broad-based and long-lasting, with the manufacturing, services and agricultural sectors experiencing reduced informality rates (Garlati-Bertoldi, 2018[16]).
Informality rate
Note: 12-month averages. Informality is defined as the percentage of workers in employment not contributing to the pension system. The statistical definition is different from the one followed by DANE. Months from April to August 2020 are missing because of the pandemic some questions were not asked in household surveys.
Source: DANE.
But despite the 2012 reduction, overall non-wage costs remain high. For a dependent formal worker earning the minimum wage, the cost of contributions and other payroll taxes amounts to 53% of the wage for an employer. Among the most expensive non-wage costs is a transport allowance, which is mandatory only for workers earning less than two minimum wages and not considered in the calculation of social contributions. The only rationale behind this allowance is its exemption from social contributions, but it constitutes a big disincentive to formal hiring.
The fall in informality accelerated its pace between 2019 and 2023, falling by 4 percentage points overall and by 10 percentage points among women. This reduction was driven by the strong post-pandemic recovery and social security employment subsidies (Banrep, 2023[17]). These subsidies, introduced during the pandemic and extended until 2026 by the current government, offer subsidies of 30% of the minimum wage for youth, 20% for women, and 10% for men. As a complementary measure to reduce effective non-wage labour costs for priority groups, the national government is implementing the “Empleos para la Vida” programme to promote, generate and protect formal employment. The programme grants a subsidy equivalent to 30% of the minimum wage for each additional young person (18–28 years) formally employed, 35% for each additional worker with a disability, and 20% and 15% for each additional woman and man over 28 years of age, respectively. Between January and October 2024, the programme benefited 230 000 workers, of whom 53% were women and 47% men.
In addition to pension and health contributions, employers also pay a 4% contribution to finance the family compensation funds (Cajas de Compensación Familiar), which offer a wide range of services from housing, education, and training programmes to sports and entertainment. Family compensation funds have increasingly been mandated by the government to provide benefits and services to non-affiliates. Still, their financing continues to rely uniquely on formal-sector labour charges (OECD, 2016[18]). Moreover, many of the funds’ services are located in the regional capitals and are unavailable to formal employees living in smaller cities or the periphery. As a result, an increasing part of the contributions to the family compensation funds is in reality a tax on formal labour that is used to finance social policy programmes for which formal workers are not eligible. For most formal workers, the benefits perceived fall short of the costs, thus incentivising informality (Levy, 2019[19]).
The unintended consequences of non-wage labour charges on formal job creation call for a broader approach to raising general tax revenues for financing social services and benefits, including the benefits provided by Family Compensation Funds. A shift towards financing services provided by Family Compensation Funds deemed worth maintaining through general tax revenues can subtract 4 percentage points from labour charges and significantly strengthen the incentives for formal job creation. If this proves politically too difficult, a temporary improvement would be to transform the current flat contribution rate into a progressive rate that spares out low-income workers, for whom formalisation incentives are most relevant. A recent revenue-neutral proposal suggests a zero contribution around the minimum wage that rises with income, but remains low below two minimum wages (Fedesarollo, 2021[10]). In this case, a centralised contribution collection system would transfer resources to the funds based on the services actually provided to low-wage members and on the number of members, considering the quality of services delivered. This would be a fundamental first step towards ensuring the progressivity of the funds and strengthening the government's position on the use of resources.
Other non-wage labour costs are related to costly and complex business regulations that hamper the formalisation of firms and jobs. The Government has been implementing a one-stop shop mechanism for all registration procedures (Ventanilla Única Empresarial), and should keep up efforts to integrate all commercial, tax and social security procedures necessary for the opening of companies and registering of formal workers. Increasing the use of digital tools would also offer the double dividend of reducing the regulatory burden while limiting opportunities for corruption and non-compliance, particularly when paired with additional efforts to increase compliance. Efforts in this direction have been undertaken with the SIMPLE tax regime that aims to reduce the tax burden but also facilitate compliance with tax obligations for micro and small firms. Take up of the SIMPLE tax regime has not been large, and there is margin to reform to improve take up and ensure objectives are met. Authorities have also implemented programmes, such as Programa para la Formalización and Crecimiento Empresarial, aiming to formalise micro and small firms.
In December 2012, Colombia’s Congress approved a reform that reduced payroll taxes by 13 percentage points of wage earnings. In particular, it eliminated employers’ contributions to SENA (the public training agency) and ICBF (the childhood services agency), previously set at 2% and 3% of firms’ payrolls respectively. The reform also eliminated employers’ contributions to the health system that amounted to 8.5% of the payroll. These payroll tax reductions applied only for workers with wages below ten minimum monthly wages (around 98% of formal workers). SENA and ICBF contributions were eliminated by mid-2013, while health contributions were eliminated starting in January 2014.
To finance this reduction of payroll taxes, authorities implemented a new corporate income tax (the “CREE”) of 9% of total profits, while reducing the existing corporate income tax from 33% to 25%. The goal of the reform was to stimulate formal employment, while keeping tax revenue unchanged. The reduction in payroll taxes did not apply to employers not subject to corporate income taxes, including firms in the special tax regime and, in particular, non-for-profit organisations, which operate mainly in the education and health sector.
Table 7.2 shows all non-wage labour costs for employers, employees and the self-employed after the 2012 tax reform. The largest single elements of the tax wedge are pension contributions (12% for the employer), transport and severance allowances (11.7% and 8.3%, respectively) for the employer and pension and health benefits (8%) for the employee.
Source: Ministry of Labour of Colombia.
Due to the low coverage of social insurance contributory schemes, cash transfer programmes were implemeneted to protect those left behind, typically informal workers in poor households. Among poor households, 83% of their employed members had worked informally in 2019. The main conditional cash transfer programmes (Table 7.3) are Familias en Acción (Families in Action), which targets poor households; Jóvenes en Acción (Youth in Action), now structured under Renta Ciudadana, which provides incentives to young people for entering and completing higher education; and Colombia Mayor, the non-contributory pension scheme.
Source: OECD based on Social Prosperity Department Management Report (2019).
Evaluations suggest that these social programmes have contributed to reducing poverty and raising well-being of households. Familias en Acción has had a significant impact on educational attainment, nutrition and other dimensions of life quality (Angulo, 2016[20]), in addition to reducing extreme poverty, poverty, and multidimensional poverty (DNP, 2008[21]; DPS, 2020[22]). On the other hand, evidence suggests that being a beneficiary of Familias en Acción may increase the probability of being informal, since having a job in the formal sector increases individual income and reduces the probability of being eligible for the program (Saavedra-Caballero and Ospina Londoño, 2018[23]). Jovenes en Acción has had positive effects on earnings and employment prospects, including formality, in the short and in the long run, and increased educational attainment for participants and their relatives (Attanasio, Kugler and Meghir, 2011[24]; Attanasio et al., 2017[25]; Kugler et al., 2020[26]).
Although they have had a positive impact on the beneficiaries that they reach, cash transfer programme coverage remains low, leaving many poor households without support (Figure 7.6). 52% of poor households do not receive any support from the state. Only 13% of households with all members working informally received support through Familias en Acción in 2019. And in 2019, only 2.7 million out of 4.3 million poor families were targeted. The coverage is similar in rural and urban areas, but poverty rates are higher in rural areas, as less-educated households in remote areas are more difficult to reach. Moreover, the system lacks policies to protect the middle class from temporary shocks that may affect their income or assets. It must be highlighted that the new programme Renta Ciudada has as an objective increasing coverage and benefits, but fiscal constraints have limited the impact.
Benefit levels of cash transfers are also low. Familias en Acción provides financial support equivalent to less than 5% of average monthly GDP per capita in 2019 (USD 23 or 22% of the poverty line), one of the lowest in emerging markets (ILO, 2017[27]), where the average is 15% (Gentilini et al., 2021[28]). Insufficient programme resources is the main reason for low coverage and benefit levels.
In addition to conditional and non-conditional transfer programmes, other social assistance programmes exist to support productive inclusion and entrepreneurship, or to cover the specific needs of certain population groups. The design of these programmes aims to cover all life stages and conditions necessary for a person or family to enter the labour market, generate income and improve life quality. However, there is a lack of coordination and efficiency in these efforts. Aware of these challenges, authorities set up an equity roundtable (Mesa de equidad) in 2019 formed by the president and all the ministries, to coordinate social programmes among all institutions targeting poverty alleviation. And in 2020, the management of all cash transfers programmes was centralised under a single public entity, a welcome step to reduce fragmentation.
Note: in Panel B, vulnerable population is defined as (a) all children; (b) persons of working age not contributing to a social insurance scheme or receiving contributory benefits; and (c) persons above retirement age not receiving contributory benefits (pensions). Social assistance is defined as all forms of non-contributory cash transfers financed from general taxation or other sources (other than social insurance).
Source: OECD calculations using GEIH 2019 and ILO, World Social Protection Database.
7.4.1. Recent changes to cash transfer systems
The Covid-19 pandemic accelerated significant changes in cash transfer systems to protect the poor and vulnerable. Programs like Familias en Acción expanded eligibility to include more economically vulnerable households and waived conditionalities due to the lockdown. Jóvenes en Acción also fast-tracked its age expansion to support young people aged 14-28, with plans to add 200,000 more beneficiaries.All existing programmes provided extraordinary cash transfers. Additionally, the government launched Ingreso Solidario, an unconditional cash transfer program aimed at informal workers, reaching up to 4.1 million households by 2022, offering COL 160,000 (USD 40) per month. This program showed positive impacts on household income, food consumption, and education (Gallego et al., 2021[29]). The government also fast-tracked the implementation of the VAT compensation program in March 2020 to offset the regressive effects of VAT on vulnerable households, reaching 1 million beneficiaries. Early evaluations suggest these programs improved household welfare and access to food (Londoño-Vélez and Querubín, 2020[30]). Together, these social responses mitigated the pandemic's impact on poverty, reducing national poverty by 2.2 percentage points in 2020. While coverage was still limited, emergency transfers fully offset income losses in rural areas, where real income even grew during the crisis.
During 2024, the implementation of the Citizen Income Programme (Renta Ciudadana) aligns with past Surveys recommendations by increasing benefits and coverage of conditional cash transfers programmes aiming to reduce poverty and support for vulnerable households The programme consolidated multiple legacy schemes (Familias en Acción, Ingreso Solidario, Jóvenes en Acción) into a unified cash transfer system targeting Colombia’s extreme and moderate poor, especially households in Sisbén IV groups A and B. In 2024, coverage reached up to 3 million households per payment cycle—around 9 million people, or roughly 17% of the total population—thus covering nearly all households in extreme poverty and a share of those in moderate poverty.
The amount of the benefit varies depending on the household's socioeconomic status. Renta Ciudadana is structured around four components, each tailored to address specific vulnerabilities among poor and extremely poor households. The Colombia sin Hambre (Colombia Without Hunger) component aimed to guarantee a minimum income floor for households facing extreme poverty and food insecurity. This was the broadest line in 2024 but was discontinued in 2025 due to fiscal constraints. This narrowed the effective coverage to 600,000–800,000 households. The Valoración del Cuidado (Care Recognition) component focuses on recognising and compensating unpaid care work, targeting female-headed households and those caring for people with disabilities. It provides COP 500,000 every 45 days and became the programme’s main focus in 2025. The Fortalecimiento de Capacidades (Capacity Building) line supports human capital development, linking transfers to participation in education or training, especially for youth. Finally, the Atención a Emergencias (Emergency Support) component provides flexible assistance during shocks such as natural disasters or economic crises. While all four components were active during the programme’s initial phase, 2025 reforms narrowed the focus primarily to the Care Recognition line in order to preserve support for the most vulnerable under tighter budget conditions.
The benefit is also designed to be temporary with the objective of transitioning households into more permanent social protection schemes. The average monthly transfer is expected to range between COP 200,000 and 400,000 (around USD 50-100), close to the extreme poverty line, although this amount can vary based on household needs and composition. For example, larger families or those in deeper poverty may receive higher amounts. Renta Ciudadana aims to bring beneficiaries closer to the poverty line but does not fully eliminate poverty for many households, particularly in urban areas, where the cost of living is higher.
While Renta Ciudadana has made progress, the program's coverage and benefit levels have been limited by budget constraints. Additionally, although there have been efforts to improve targeting of social policies by introducing a new social registry, it remains a challenge, with the risk that some households in need might be excluded or miss out on benefits due to incomplete data or inefficient registration systems.
To sustain incentives for formal employment and prevent disincentivising beneficiaries from seeking formal work due to fear of benefit loss, a tapering phase, where the reduction in transfer value is less than the additional income earned, would encourage formal work uptake. Cash transfers can also be linked to pro-formal employment behaviours such as skills training, and engagement with public employment services, facilitating poverty alleviation efforts (OECD, 2022[31]).
7.4.2. A guaranteed minimum income could provide a backstop against poverty
The implementation of Renta Ciudadana, a unified social program that integrates existing cash transfers. marks an inflection point for Colombia and the future of cash benefits. This represents a significant step forward in expanding coverage and improving social protection for the most vulnerable. Moving forward, a further improvement would be to establish a guaranteed minimum income scheme for the population aged below 65, which would complement the incomes of those living in poverty. This programme could become the prime poverty alleviation instrument and provide a backstop to those who lose their livelihoods temporarily in the case of dismissal or income loss. Other social programmes that aim at improving household assets and human capital could serve a complementary role.
A guaranteed minimum income is a periodic cash transfer that supplements the income received by poor households to ensure a minimum income level. The scehme would be financed by general taxation revenues, and could build on existing conditional and un-conditional cash transfers for the vulnerable and poor. The amount given to each household would be related to the household's own income before the transfer (from both formal and informal jobs) and assets. If the household has no income, the maximium transfer amount would be made. As household income increases, the transfer amount would gradually decrease until income reaches a point at which the household would no longer be eligible for any transfer. Renta Ciudadadana has move in this direction, as the amount of the benefit depends on the size and degree of vulnerability of the household. This system differs from existing cash transfers, which provide a fixed amount to poor households independent of the household or individual income (usually called basic income schemes). When children are part of the household, the transfer could be conditional on human capital accumulation and desired health behaviours, as in the Familias en Acción programme, to generate incentives for investing in education and health. In line with the current cash transfer programmes, benefit levels would take into account children’s age and educational level.
To maintain the incentive to work, and in particular, to work formally, it is important that cash transfer programmes are designed so that a beneficiary moving into employment forgoes a transfer smaller than the additional income gained from working formally. To this end, the program could include a phase in which, for every additional peso earned by the household or individual, only some part of the self-declared additional earnings, including both formal and informal earnings, are taken into account to calculate the cash benefit, until gradually reaching a point where no subsidy is available (Reyes, 2020[32]). Preliminary and ex-post impact assessments should be systematically conducted to evaluate the effects on (formal) labour force participation and adjust the design where necessary.
The level of the guaranteed minimum income should also take into account the poverty line to ensure no household is left in poverty. By incorporating the national definition of the poverty line into its calculation, the minimum income would also naturally adapt to the varied cost of living in the different territories and changes in prices over time. Hence, the most efficient way to fight poverty would be to establish a minimum guaranteed income equivalent at least to the poverty line, while eliminating all other subsidies or tax exemptions. Unifying all income support into one programme would make it more efficient and transparent, which could in turn increase popular support for the reform.
The programme should be accompanied by an effort to strengthen state capacity to regulate and administer the system, including systems for income and wealth reporting and verification. Local networks and social assistants would play a key role in income verification. Also important would be designing incentives to encourage citizen responsibility, for example by implementing some kind of penalty for those who provide inaccurate or false information (Andes University, 2020[33]).
An almost equivalent alternative to a guaranteed minimum income would be a Negative Income Tax or Earned Income Tax Credit. In such a programme, the subsidy would decrease gradually as earnings increase. After a certain income level, an individual would no longer benefit from the subsidy and instead begin to pay earned income taxes. Evidence shows that the Earned Income Tax Credit in the United States has raised labour force participation, particularly for single mothers, a group that previously faced the greatest disincentive to work (Hoynes and Patel, 2017[34]). There are also positive impacts on poverty reduction, as the programme rewards work and supplements the income of low-wage workers. These programmes have also decreased informal employment in developing countries (Gunter, 2013[35]). The salient distinction between a guaranteed minimum income and the negative income tax is that the latter is financed directly through the progressive income tax. Another important difference is that the former allows for some part of the cash transfer to be conditional on educational and health behaviours. Also, in the case of the guaranteed minimum income, a network of social workers is in charge of verifying and constantly improving the database of poor households while raising awareness of available benefits, while under a negative income tax, tax inspectors would do this work instead, which might make their work more difficult.
Risks arising from the loss of employment among formal workers are currently covered through three different instruments. The first is severance pay, consisting of a fixed one-off payment paid by the employer to the worker at dismissal. The amount depends on the worker’s salary, ranging between the equivalent of a month and a year’s salary. The second is an unemployment protection scheme based on individual accounts, financed by individual savings accumulated by through contriubtions. In March 2021, around 9 million people were affiliated with individual severance accounts (cesantías), corresponding to 95% of all formal salaried workers. Of self-employed workers, however, only 8% contribute to this system.
The individual unemployment savings account system fails to provide proper income protection. Over time, the system has lost its purpose, as workers can withdraw their savings before job loss for a variety of reasons, including financing education or purchasing or renovating a home. In 2017, two thirds of the funds were withdrawn for reasons other than unemployment (ACRIP and Fedesarrollo, 2018[36]). In 2013, to redirect the system of individual severance accounts towards income support provision in the case of unemployment, the government introduced a bonus proportional to the savings amount for those who keep at least 10% of their savings in the fund, 25% for those who earn more than twice the minimum wage (OECD, 2016[18]).
The third is an unemployment insurance benefit (Mecanismo de protección al cesante), established in 2013 to complement individual savings accounts. It partially replaces lost wages, ensures the continuation of health and pension contributions for six months, and provides income-support for families with children, and access to public employment services and vocational training and employment offers. It is granted to formal workers who lose a job and whose employer contributed 4% of the payroll to a family compensation fund for at least 12 months in the three years before the job loss (24 months for self-employed workers). Although this benefit has substantially expanded since its introduction, most unemployed people do not qualify, either because are informal or because their employer did not contribute long enough. This explains the poor targeting of this protection mechanism: 82% of resources go to non-poor households and 53% to the two highest income quintiles (Fedesarollo, 2021[10]).
The unemployment insurance system proved insufficient for compensating formal workers for income losses during the pandemic. To compensate, the government implemented a transfer equivalent to two minimum wages over a period of three months during the lockdowns for those earning less than four minimum wages. By late June 2020, nearly 800,000 applications for unemployment insurance had been received, but only 109,000 people had actually been granted insurance. By December 2020, more than 400,000 unemployment subsidies were approved. Given the high number of newly unemployed workers on the waiting list, the government injected the unemployment protection mechanism with resources from the general budget and in early June authorised some of these individuals to be included in the Ingreso Solidario cash transfer programme for vulnerable workers (Blofield, Lustig and Trasberg, 2021[37]).
Ingreso Solidario provided a backstop for those losing their job or income as a result of the Covid-19 pandemic. The success of this program at supporting the unemployed during the pandemic indicates that a cash benefit programme to the poor could serve as a universal pillar of an improved unemployment insurance system. For workers earning the minimum wage, a cash benefit equivalent to the poverty line would imply a 40% wage replacement rate. This would allow job seekers to look for jobs without an immediate concern for survival, improving workers’ bargaining power and the probability of obtaining fair wages.
As part of the proposed guaranteed minimum income, beneficiaries would also be automatically registered with the labour market intermediation services to receive support in their search for employment and training. As this pillar is designed to avoid poverty in the case of job loss, a second contributory pillar could exist to provide consumption smoothing and maintain living standards for workers above the minimum wage, with the goal of achieving a wage replacement rate more in line with other OECD countries (60% on average).This second pillar would provide top-up benefits and be based on existing individual unemployment accounts financed from individual savings accumulated by workers.
One advantage of individual unemployment savings accounts over other unemployment insurance systems is that they significantly limit the risk of moral hazard (ILO, 2019[38]). By allowing workers to run down their personal savings during periods of unemployment, workers internalise the cost of unemployment benefits, thus strengthening incentives for the employed to prevent job loss and for the unemployed to return to work quickly. Individual unemployment savings accounts also strengthen incentives for formal work since social security contributions to individual accounts are perceived less as a tax on labour and more as a delayed payment (OECD, 2018[39]). The disadvantage of individual unemployment savings account system is that individuals with lower contributory capacity, who also tend to have a higher risk of unemployment, generally tend to receive insufficient protection. This is why these systems are often supplemented to support individuals with lower contributory capacity. The guaranteed minimum income programme would act as such a supplementary support.
The current individual unemployment savings accounts system would need improvements to regain its income protection role during periods of unemployment. An important first step is to restrict withdrawals to instances of dismissal. If the worker does not withdraw all of the contributions accumulated during their career, any surplus could be credited in the form of pension entitlements upon retirement, a practice already in existance in Chile. Contributions to the severance accounts could be limited to a maximum number of years to allow for a sufficient accumulation of resources to cover the eventuality of unemployment.
As the benefits received from the severance accounts provide top-ups to the guaranteed minimum income programme, contributions to the individual accounts could be substantially reduced. Employers are currently mandated to contribute to the employee’s severance account around 8.5% of the payroll and 12% of interest on the annual amount of the severance pay. These contribution rates are high even compared to advanced countries (ILO, 2019[38]).
The Colombian pension reform (Box 7.1), currently being implemented, aims to address longstanding issues of low coverage, fragmentation, and inequalities within the system. Despite progress, challenges remain, including persistently low coverage for informal workers and the fiscal burden of the current system.
The pre-reform pension system is characterised by a complex structure: a contributory system, a non-contributory scheme as a cash transfer (Colombia Mayor), and a voluntary savings scheme (BEPS). The contributory system consists of both a public defined-benefit system and a private capitalisation scheme, operating simultaneously, competing against each other. The coexistence of two contributory schemes operating under different rules means that two workers with identical contribution histories can acquire different pension entitlements at retirement. This contributory system is characterised by low coverage—only 25% of the elderly receive a contributory pension (Figure 7.7), and this is projected to decrease to less than 20% by 2050 (Bosch et al., 2015[40]). This low coverage stems from high informality in the labour market and the exclusion of many workers who do not meet the system's requirements (Table 7.4). Inequality is another key issue, with significant benefits flowing disproportionately to higher-income groups, as the public system fills gaps for high earners, creating implicit subsidies.The average income replacement rate in the public benefit-defined scheme (73%), which supports higher-income earners, is also much higher than that of the private capitalisation scheme (39%) (López and Sarmiento, 2019[41]), or the OECD average (58%).
As a whole, pension spending is the worst-targeted item of social spending in Colombia, with 73% of subsidies going to high-income households, and just 5% going to the poorest households. In fact, Colombia is the only country in the region in which contributory pensions increase inequality (Lustig, 2016[42]). There are also marked inequalities in pension coverage across population groups, with a coverage rate for women of 21%, compared to 30% for men. In rural areas, less than 10% of the elderly are covered.
The fiscal cost of the pension system, which includes several special regimes for public sector employees, such as military personnel and teachers, is also high in relation to its coverage at 3.9% of GDP and nearly 30% of government tax revenues in 2019, nearly three quarters of which were subsidises to the public scheme.
The non-contributory scheme, called Colombia Mayor, provides small cash transfers to the poorest of the elderly and has expanded in recent years (DNP, 2016[43]; Econometria, 2017[44]). This scheme is far from sufficient, covering just 39% of those older than 65 with no contributory pension in 2019, or 29% of the total population aged 65 and above. Average benefits are also low, at about 60% of the extreme poverty line, or USD 25 per month (the benefit is higher for those over 80 years of age), making Colombia Mayor one of the least generous non-contributory pension systems among emerging market economies (ILO, 2021[45]).
The so-called Periodic Economic Benefits Scheme (BEPS) is the third pillar of the Colombian pension system after contributory and non-contributory systems. Its original aim was to encourage voluntary savings for retirement among low-income Colombians. But design problems and its reliance on voluntary savings by a low-income population limit its impact and take-up.To increase pension coverage among low income earners, the government implemented a “social protection floor” in 2020, making contributions to BEPS for dependent and independent workers earning less than a minimum wage, and providing pension transfers, non-contributory health coverage, and additional insurance against labour risks (for which the employer contributes 1% of the wage). For those with earnings above the minimum wage, the social protection floor was voluntary.
Source: OECD Secretariat.
1. OECD refers to the unweighted average of latest available data of its member countries excluding Australia, Israel and Switzerland.
2. Data refer to 2018 for Colombia. Latest available data for the remaining countries.
3. Year 2019 based on GEIH. Source: Colpensiones; Finance Ministry of Brazil; Ministry of Economy of Argentina; OECD Pensions at a Glance: Latin America and the Caribbean (2014); OECD Pensions at a Glance 2019, OECD Stat Pension spending, OECD/IDB/The World Bank (2014), Pensions at a Glance: Latin America and the Caribbean and Fedesarrollo (2021).
The recent pension system reform (Box 7.1) is heading in the right direction by aiming to enhance the coverage of non-contributory pensions and eliminate competition among contributory schemes, and will help reduce inequities and poverty. This reform also reduces implicit subsidies to the wealthy under the pay-as-go system, where most affluent retirees captured most of the benefits. The reform involves transitioning from the current system to a pillar system. The first pillar entails a non-contributory tier that provides a minimum income equivalent to the extreme poverty line to all mean aged 65 and women aged 60 and above living in poverty. The second pillar focuses on semi-contributory pensions for workers who have contributed to the system but fall short of the requirements for a full pension. The third pillar comprises the existing pay-as-you-go and private individual account systems, but all workers contribute to the pay-as-you-go system and only those earning more than 2.3 minimum wages to the private individual accounts. This limits subsidies for high earners, and redistributes public support toward lower-income workers.
Firstly, the pension reform increases benefits and coverage for all citizens by guaranteeing a pension to those unable to attain a contributory one, ensuring no elderly falls in extreme poverty. The reform also provides pension benefits for those workers that contributed but did not achieve the required minimum 1,300 weeks of contributions for men and 1,000 weeks for women though a new semi-contributory pillar. Currently, these individuals are only entitled to the return of their contributions without any interest accrual. This is largely welcome as the current pension system exacerbates inequities leaving many elderly people in poverty given the low coverage among the most vulnerable. While this is an improvement from the previous scheme, in the medium term it would be advisable to enhance benefits within the non-contributory pillar to prevent anyone from falling into poverty, while ensuring fiscal responsibility in the process.
Secondly, the reform unifies the two current competing contributory schemes. The contributory system allowed members to choose between a state-run defined benefit plan and an individual defined contribution savings account plan managed by private pension fund administrators. The reform enlarges the public pay-as-you-go system by redirecting contributions from the private funds towards the public system. Only workers earning more than 2.3 times the minimum wage will contribute to the private pension funds for earnings above this threshold. Around 75% of all contributions to the contributory pillar will go to the public defined-benefit component. A new public savings fund, accumulating capital redirected from private funds and contributions to the public scheme after the reform, will be managed by the Banco de la República, whose independence ensures credibility in resource management. Thirdly, the reform improves targeting by increasing subsidies to low-income workers through the solidary and semi-contributory pillars and reducing them for high-income workers in the contributory pillar when contributions fall short of outlays.
In the medium to long term, given the current aging process and to ensure fiscal sustainability of the reform (as discussed in the (2024[5]) Economic Survey of Colombia) the government will need to consider parametric reforms. There are two alternatives. First, lowering the threshold from which workers need to contribute to the private pension funds, as now it is relatively high with less than 15% of all workers earning above the 2.3-monthly minimum wages. This would have the advantage of encouraging national savings and capital market depth. Second, changing the calculation of pension replacement rates. Replacement rates are generous by international standards in the public scheme, at 72% of pre-retirement earnings in 2022, compared to an OECD average of 62% (OECD, 2022[31]). The average wage over lifetime could be used to calculate the pay base, instead of the last ten years of wages (Mejia, 2023[46]). Additionally, Colombia could also consider raising the retirement age (currently 57 for women and 62 for men) and equalising the retirement age for men and women (OECD, 2015[47]). Tying pension age to life expectancy would facilitate small and automatic adjustments as life expectancy increases.
Efforts to increase labour formality will be fundamental to expand the coverage of the contributory pension scheme. The low coverage of the current scheme (25% of all workers) is primarily due to high labour informality and that only workers with a full-time monthly minimum wage can contribute. The pension reform might encourage workers to contribute to the system by granting access to the semi-contributory pillar after 300 weeks of contributions. The pension reform also encourages contributions as contributions will be based on a daily minimum wage, with a minimum requirement of one week's worth of contributions, for independent and part-time workers. However, simulations indicate that by 2100 only 22% of the old-aged will belong to the contributory system (Universidad de los Andes, 2023[48]), and most workers will belong to the semi-contributory pillar. This suggests, there is a need of further measures to ensure workers have the incentives to contribute for the full earnings and working life.
Universal coverage of the pension system while reducing the incentives for informality could be achieved by transitioning to a non-contributory universal tier, with the mandatory contributory tier that tops-up benefits from the first tier. The first, non-contributory universal tier would provide minimum pension benefits for all residents aged 65 and above. Benefit levels would focus on reducing old-age poverty, while leaving consumption-smoothing objectives for the other components. The need to strengthen the incentives for formal job creation calls for shifting the financing burden of pensions away from (formal) labour towards broader sources. Essentially, this implies financing the universal pension from general taxation revenues, as opposed to labour charges. This would generate a need for mobilising additional tax revenues, which is a key priority for Colombia. Such a universal minimum pension, would allow to reduce social contributions, at least for low-income workers, boosting formality. Mandatory contributory rates could be progressive, lower for workers earning the minimum wage or below, and increasing gradually for workers earning higher wages. To ensure adequate pension amounts and fiscal sustainability, contribution rates could be calibrated to achieve replacement rates of at least 60% of pre-retirement earnings, close to the average OECD replacement rate for men.
Colombia has achieved almost universal healthcare coverage, with 97% of the population covered by the public health system in 2020, one of the highest coverage rates in the region. The country has simultaneously achieved very high financial protection, with out-of-pocket expenditures below the OECD average and the lowest in the LAC region, a remarkable achievement (Figure 7.8).
However, the design of the public health system, which consists of two parallel schemes (a contributory scheme for formal workers and a non-contributory scheme) incentivises informality for three reasons. First, the non-contributory system offers nearly the same services as the contributory one, with the exception of disability allowance and maternity leave, but is free of charge. Second, part of formal workers’ healthcare contribution is used to cross-finance the non-contributory system and thus is effectively taxed away. Finally, workers face a temporary discontinuity in healthcare coverage when switching between systems due to their change in employment status. These switches can also negatively impact the quality of care as medical files and treatment histories are usually not shared across the two systems.
Improving incentives to formalise while keeping good health coverage would require shifting much of the financing burden of public healthcare away from formal labour charges and toward general taxation, especially for workers earning around the minimum wage where disincentives are highest.
Moving towards a single, universal health care system financed through general taxation would reduce by 4 percentage points the cost differential between formal and informal employment, which is currently paid by the employee. For self-employed workers, this would reduce the cost differential between formal and informal labour by 12.5 percentage points, and even more for those earning less than a minimum wage. Funding the health system by not discriminating between formal (contributing) and informal (non-contributing) workers would boost formality (Levy, 2019[19]).
A second option that could be implemented at no fiscal cost is to unify the two existing systems and keep the financing through labour charges, but shift the burden of contributions more heavily onto higher income workers and less on workers earning around the minimum wage. One recent proposal sets at zero the contribution rate for salaried or self-employed workers earning up to one minimum wage, and then increases the rate gradually up to a maximum for workers earning 25 minimum wages (Fedesarollo, 2021[10]). This would leave the average contribution rate at around 4% of wages, implying no fiscal cost, but would make contributions more progressive, lowering the cost of formalisation.
Reducing healthcare-related labour charges and the associated distortions is particularly important for those firms subject to the “special tax regime,” which account for 16% of all formal employment, mainly in the sectors of education and health. The special tax regime features an additional 8.5% employer health contribution, as the regime was not included in the 2012 reform due to its exemption from corporate taxes, generating even stronger disincentives to formal job creation. Moreover, as these sectors employ 26% of female workers, reforming them would help to improve gender equality.
Source: OECD Health at a Glance, 2020 and (Fedesarollo, 2021[10])
Illustrative simulations based on microdata from the Colombian household survey (GEIH) allow for an estimation of fiscal costs and impact on poverty and inequality of different social protection reforms in Colombia. actual costs will depend on the details of the reform and its implementation. Furthermore, the cost estimates can only provide an upper bound in the short run, as they are based on the current status quo, and do not account for the medium-term benefits from improvements in labour incomes, inequality and productivity. Such medium-term benefits are notoriously hard to estimate in a reliable way, but they are the ultimate reason why such a reform should be undertaken.
A basic, non-contributory, universal pension for all individuals aged 65 and above would cost 1.6% of GDP in 2020 (Table 7.5). The corresponding benefit would amount to a 4-fold increase vis-à-vis the current non-contributory Colombia Mayor programme and imply a replacement rate of around 50% for a minimum-wage earner. Taking into account demographic changes, and maintaining the benefit at this level, the cost of the universal basic pension would peak at 2.6% of GDP in 2030, fall to about 1.8% of GDP in 2060 and 0.7% of GDP by the end of the century (Fedesarollo, 2021[10]).
Note: The calculations imply subtracting from households’ income all transfers based on social programmes, such as Colombia Mayor, Familias en Acción and Ingreso Solidario, and replacing them by transfers based on the new proposed programmes.
Source: OECD Secretariat calculations based on DANE-GEIH data.
A guaranteed minimum income programme, topping up to the poverty line all incomes of those below 65, net of current government transfers, would cost 4% of GDP in 2020. This number is clearly higher than the expected cost in the future, given the extraordinary increase in poverty rates during 2020. Once poverty rates return to pre-pandemic levels (2019), the estimated cost would be around 2.5% of GDP. A reasonable conservative medium-run cost estimate may be around 3% of GDP (Table 7.5). An alternative option with similar fiscal cost but lower impact on social outcomes would be a basic income programme, similar to the current social programmes (Renta Ciudadana), delivering a fix benefit to all households in poverty regardless of their income or wealth. If a basic income programme were pursued, delivering a benefit equivalent to the extreme poverty, the fiscal cost would be of 3.9% of GDP in 2020, only slightly lower than that of the guaranteed minimum income. For a similar cost, the guaranteed minimum income provides a higher minimum income floor, assuring no one is left in poverty.
These reforms together would initially cost 5.4% of GDP, but the net cost, after phasing out existing cash transfer programmes and subsidies on public services, would fall to 3.7% of GDP (Table 7.5). This takes into account the expected savings in spending on current social assistance programmes, such as Familias en Acción, Ingreso Solidario and Colombia Mayor (which have now been replaced by Renta Ciudadana), whose transfers to the poor were worth 1.2% of GDP in 2020, and public subsidies of around 0.5% of GDP. With the new pension reform already approved, subsidies to high-income pensioners worth 2.6% of GDP are set to be phased out gradually. That would reduce the long-run net cost of a deep social protection reform to around 1% of GDP. Even in the short run, a smaller part of the pension savings could be frontloaded by subjecting high pensions from the current system to income taxes.
Finding alternative financing mechanisms to employee contributions for the contributory health scheme and employer’s contributions to the Family Compensation Funds would imply funding needs equivalent to 2.2% of GDP, based on 2019 household data. Social contributions of workers with higher incomes, i.e. above 1.5 minimum wages, which accounted for 1.4% of GDP, could be simply replaced by personal income taxes of the same amount. That would leave a remainder of around 0.8% of GDP to be financed by general taxation revenues instead of social security contributions, as workers with incomes close to the minimum wage are unlikely to become subject to personal income taxation in the near future.
In general there is significant scope for raising tax revenues in Colombia, as it currently raises around 1.9% of GDP less in general government revenues than the average economy in Latin America, and 12.4% of GDP less than the average OECD economy (OECD, 2024[5]). In the short term, existing exemptions that dampen tax collection and the progressivity of the tax system should be removed, tax rates on high incomes should be increased, and tax bases for corporate and personal income taxes broadened. In the long term, the higher rates of employment formalisation and growth that can be expected as a result of these reforms would increase incomes, in turn increasing tax collection.
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← 1. As with the rest of this book, this chapter defines informal employment as every type of worker not contributing to social security, i.e. the pension system. The payment of the pension contributions is highly related to all the remaining social contributions (such as health) or the non-compliance of other employment regulations.