Wage-Shifting Effects of Severance Payments Savings Accounts in Colombia

• BSE Working Paper: 110605 | September 15
• Keywords: Severance Pay , Distortion , Tax Shifting , Individual Accounts
• JEL codes: H2, E2, J3, J6
• Severance Pay
• Distortion
• Tax Shifting
• Individual Accounts

In 1990 Colombia replaced its traditional system of severance payments with a new system of severance payments savings accounts (SPSAs). Although severance payments are often justified on the grounds that they provide insurance against earnings loss, they also increase costs for employers and distort employment decisions. The extent of these distortions depends largely on how much of the costs of severance pay can be shifted from employers to workers. One reason why the effects of severance pay may not be completely shifted is that workers may fear the firm will “take the money and run” by declaring bankruptcy. A system of SPSAs eliminates this moral hazard problem, so it should facilitate the shifting of severance payments costs to workers in the form of lower wages. Empirical results using the Colombian National Household Surveys indicate that the introduction of SPSAs lowered wages by between 60% and 80% of total severance payment contributions. These results are consistent with increased shifting after SPSAs were introduced.