Description

Despite recent improvements, Paraguay's high labor informality constrains productivity, revenue mobilization, and inclusive growth. This paper examines the drivers of informality and evaluates policy options to strengthen formalization using two complementary approaches. First, a structural overlapping generations model assesses the macroeconomic and distributional effects of alternative formalization strategies. Second, IMF TaxFit microsimulations analyze how taxes, social security contributions, pensions, and benefits shape incentives to enter and remain in formal employment. The results suggest that policies that raise productivity and improve the attractiveness of the formal sector generate larger and more inclusive gains than approaches relying primarily on enforcement. At the micro level, discontinuities in tax and pension rules weaken incentives to formalize, while targeted reforms that smooth effective tax rates, strengthen the link between contributions and benefits, and reduce the cost of formal work can improve labor market incentives while supporting fiscal and social objectives.

More publications in this series: Selected Issues Papers