VZCZCXYZ0000
RR RUEHWEB

DE RUEHBO #1829/01 1591653
ZNR UUUUU ZZH
R 081653Z JUN 09
FM AMEMBASSY BOGOTA
TO RUEHC/SECSTATE WASHDC 9093
INFO RUEHBR/AMEMBASSY BRASILIA 8951
RUEHCV/AMEMBASSY CARACAS 2312
RUEHLP/AMEMBASSY LA PAZ JUN LIMA 7617
RUEHZP/AMEMBASSY PANAMA 3712
RUEHQT/AMEMBASSY QUITO 8319

UNCLAS BOGOTA 001829 
 
SENSITIVE 
SIPDIS 
 
WHA/EPSC, WHA/AND 
 
E.O. 12958: N/A 
TAGS: ECON EINV EAID PGOV PREL CO
SUBJECT: THE INFORMAL COLOMBIAN ECONOMY - WHY IS IT SO 
PERVASIVE? 
 
¶1. (SBU) Summary: Despite several years of strong economic 
growth and economic liberalization, much of Colombia's 
economic activity continues to fall in the informal, 
unregulated and untaxed sector. Estimates of the size of the 
informal economy range from 48 to 60 percent of GDP, 
depending on how "informal" is defined. Experts attribute the 
continuing pervasiveness of informality to complex tax rules, 
difficulties in registering businesses, and a tradition of 
public acceptance. Nevertheless, informality poses an ongoing 
challenge to addressing Colombia's long-term social services 
imbalances, ensuring all Colombian workers have access to 
basic social protections, and increasing competitiveness. 
Although the GOC has begun to take small steps towards 
reducing informality, further tax, labor and business 
registration reforms will be needed to significantly address 
the structural causes of informality. End Summary 
 
Defining Informality 
--------------------- 
 
¶2. (U) The challenge in addressing Colombia's high level of 
informality begins with the lack of a clear definition of the 
informal economy. While often associated exclusively with 
illegal economic activities or unreported economic activities 
intended to avoid taxes, the informal economy in Colombia 
more broadly consists of all economic activities that 
circumvent the costs, and rights, associated with commercial 
licensing, labor contracts, financial credit and the social 
security system. Recent estimates provided by both 
international and local institutions suggest the informal 
economy accounts for up to 60 percent of the total Colombian 
economy as a percentage of GDP. However, most estimates do 
not account for the illicit economy linked to the drug trade, 
for which economic estimates vary widely. 
 
¶3. (U) For the Colombian National Statistics Agency (DANE), 
two key measures contribute to the calculation of 
informality: informal employment and informal enterprise. 
DANE reports that since 2001 informal employment has 
fluctuated between 57 and 61 percent of total 
employment--meaning the majority of employable Colombians do 
not have full access to legally required benefits such as 
social security, health care, retirement and worker's 
compensation. DANE reports 59 percent of all microenterprises 
(firms with less than 10 employees) are similarly informal 
and unregulated. 
 
 
Causes of Informality 
---------------------- 
 
¶4. (SBU) According to Roberto Steiner, Executive Director of 
the prominent Colombian think-tank FEDESARROLLO, excessive 
taxes and a burdensome tax filing system are the greatest 
disincentives to formalization for Colombian micro and small 
enterprises. According to the World Bank's 2009 Doing 
Business Report, Colombian firms on average spend 256 hours 
making a required 31 different tax payments, for a total tax 
rate of 78.4 percent (as a percentage of total commercial 
profit). The Latin America regional average is 50 percent. 
Comparing tax processes and tax rates of 181 world economies, 
Colombia ranks 141st and is less competitive than many Latin 
American countries. Thus, tax evasion often serves as the 
primary motivator for small Colombian businesses to remain in 
the informal economy. 
 
¶5. (SBU) Significant administrative costs and a lack of 
transparency in registering businesses also impede the 
formalization of many small businesses. According to the 
World Bank's 2009 Doing Business Report, Colombia ranks 79th 
in business registration practices across 181 countries. On 
average, a Colombian will spend 36 days completing 9 
procedures at a cost of 14 percent of the average Colombian's 
annual earnings to register a business. Ricardo Duarte, 
Vice-Minister of Commerce, Industry and Tourism highlighted 
the challenge further by telling us that simply accessing 
registration services remains too complicated and unavailable 
in many communities, creating a de facto impediment equal to 
the cost barrier. 
 
¶6. (SBU) Finally, inaccurate perceptions about the actual 
size and impact of the informal economy have fostered 
widespread acceptance of informality. Imelda Restrepo de 
 
Mitchell, Director of Economic Studies for the National 
Association of Industries (ANDI) told us such acceptance has 
allowed the informal sector to become entrenched, deepening 
workers' dependency on informal employment and exacerbating 
the need for the few large formal sector companies to 
subsidize social service institutions. In a recent interview 
in Portafolio Magazine, Steiner estimates that the five 
largest Colombian firms effectively pay 80 percent of all 
corporate taxes in Colombia. In separate discussions, Rodolfo 
Amaya, Executive Director of the Council of American 
Companies echoed Restrepo and Steiner, noting 10 percent of 
the entire tax base of Colombia is generated by 127 large 
U.S.-owned enterprises. Colombian tax policies subsidize 
social services with formal enterprise revenue, effectively 
serving as a disincentive to formalization and employment 
generation. 
 
 
Informality's Corrosive Impact 
------------------------------- 
 
¶7. (SBU) As a result of Colombia's extensive informality, 
more than 10 million workers go without formal health, 
worker's compensation, and retirement benefits. Moreover, the 
sheer size of the informal economy, and consequent lost tax 
revenue, affects the fiscal viability of Colombia's formal 
social security institutions to provide services. Previous 
GOC efforts to make up the shortfall between contributions 
and social service needs led to increasing the burden on the 
large companies through a set of taxes called 'parafiscales'. 
These taxes, equivalent to 9 percent of a firm's cost of 
labor, currently finance Colombian institutions responsible 
for workers' compensation, the National Training Service 
(SENA), and the Colombian Institute of Family Welfare 
(Bienestar Familiar - ICBF). Steiner notes that in part due 
to the parafiscales, for every 100 pesos a firm pays an 
employee, the real cost to the employer is 160 pesos. 
Alejandro Gaviria, Dean of Economics at the University of the 
Andes, told us the parafiscales have created an informality 
trap--serving as a disincentive for firms to register, report 
income, pay taxes, or invest in salaried/skilled labor, 
rather than a solution to the social security fiscal dilemma. 
 
¶8. (SBU) In addition to the social and fiscal implications, 
experts blame informality for impeding Colombian 
competitiveness. Specifically, firms participating in the 
informal economy do not have equal access to financing, 
international markets, or subsidized training. Dr. Pedro 
Villabon, Director of Microenterprise Banking at Colombia's 
National Development Bank (BANCOLDEX) told us Colombian firms 
operating informally lack access to financial services, 
restricting their ability expand, minimize fluctuations in 
cash flow, and invest in new technologies or skilled labor. 
Informal firms also lack legal recourse to pursue payments, 
resolve claims, or participate in government procurement - a 
significant part of the Colombian economy. ANDI Director of 
Economic Studies Restrepo added that Colombian firms 
competing internationally are at a disadvantage when their 
production chains are unavoidably wedded to informal sector 
suppliers that face no legal recourse for failing to deliver 
on time, breaking contracts, or producing inconsistent 
quality products with poorly trained staff. Formal taxpaying 
firms are disadvantaged further, lacking access and control 
over revenues. According to the 2009 World Bank Doing 
Business in Latin America report, comparing economies of 17 
Latin American countries, Colombia is average in level of 
effort needed to pay taxes. However, Colombian firms pay a 
total tax rate of 78.4 (as a percent of commercial profits) 
ranking second from last (exceeded only by Argentina). This 
places Colombian firms at a distinct regional disadvantage 
comparing firms, abilities to leverage and invest profit. 
 
Finding a Way Forward 
---------------------- 
 
¶9. (SBU) Recognizing that the heavy tax burden and complex 
business registration requirements have fueled informality, 
the GOC has begun to take small steps to address the root 
causes. On May 27, 2009, Colombia's tax authority initiated a 
scaled labor tax payment system for all businesses. 
Previously, a firm was responsible for paying 100 percent of 
all labor taxes for an employee, regardless of the number of 
hours the employee worked per month. Under the new system, 
 
firms will report the number of hours an employee works per 
month as a percentage of full-time employment, and pay the 
equivalent percentage of labor taxes. The aim is to lessen 
the tax burden firms associate with formalizing labor and 
encourage investment in salaried/trained labor. However, 
Vice-Minister Duarte admitted that this policy is only a 
"second-best solution" next to eliminating parafiscales and 
finding collection efficiencies within the existing tax base 
to pay for social programs. Duarte acknowledged that scaling 
taxes based on part-time but permanent labor could help 
encourage investment in labor, reporting of actual number of 
employees and increase tax revenue. But he also warned the 
policy still encourages under-reporting of employees and 
creates additional administrative burdens for GOC tax 
authorities. Steiner advises getting rid of special tax 
schemes, folding parafiscales into normal tax structures, and 
working to increase the tax base rather than unfairly burden 
firms that do pay taxes. 
 
¶10. (SBU) Outside experts such as Gaviria say the GOC should 
broaden policies to incentivize formalization, including tax 
cuts for firms that generate employment, rather than raise 
taxes on existing formal firms that do pay taxes now. 
Santiago Levy, Director of Research for the Inter-American 
Development Bank specifically blames the parafiscales for 
"trapping the poor in poverty". Colombia's small formal 
sector bears a disproportionate burden of financing social 
service institutions. Gaviria told us that a more appropriate 
approach would be to lower taxes and make labor rules more 
flexible, thereby lowering the cost of hiring permanent 
employees and registering them with social service 
institutions. 
 
 
Comment 
-------- 
 
¶11. (SBU) Colombia has made progress in recent years reducing 
poverty through growth and liberalization. However, pervasive 
informality remains arguably the most significant bridle to 
broad poverty reduction in Colombia and ensuring an adequate 
social security net for all Colombians. While the small steps 
so far to reduce barriers to formalization are headed in the 
right direction, a broader paradigm shift away from heavy 
taxation and rigid bureaucracy will be necessary to truly 
break the cycle of informality. 
Brownfield