This paper studies the effect of prohibiting the use of cash for wage disbursements on labor markets in developing countries. We study a reform in Uruguay that mandated wage payments to be disbursed using electronic methods. Using a difference-in-differences approach based on pre-reform sector-level cash intensity, our results indicate that firms in high cash intensity sectors are significantly more likely to discontinue formal activities post-reform. Active firms show a slight reduction in the number of employees and an increase in reported wages. These results are driven by low productivity firms. Complementary results using survey data indicate an increase in informal employment and a decrease in collusive underreporting of earnings partially explain these results. Overall, results suggest that, while eliminating cash for wage payments enhances tax compliance among formal workers, it may also shift some economic activity into full informality, offsetting the revenue gains from improved payroll tax compliance.

This paper examines bunching responses at kink points in the effective marginal tax-benefit schedule, capturing the interaction of income taxation, social security contributions, pension benefits, and informality. Using Brazilian matched employer-employee administrative data, we proceed in three steps. First, we identify workers who bunch at the kink created by the pension-benefit cap, documenting how intensity varies across worker types, sectors, and firm sizes. Second, we assess the impact of payroll tax reductions on bunching, quantifying how lower labor taxes shape worker responsiveness. Third, we investigate whether transitions to the simplified Simples tax regime affect bunching independently of social security incentives, isolating the role of tax simplification. Theoretically, we extend Saez (2010) and Chetty et al. (2011) by incorporating the discounted value of pension benefits into effective marginal tax-benefit rates and showing analytically how access to informal income amplifies bunching at kinks.

We explore the effects of a minimum wage hike in 2018 and an upward revision in the first kink in the progressive income tax schedule in 2017 in Zambia, to compare their impacts on wages in both the formal and informal sectors. We show that the minimum wage effects spill over into the informal sector despite being targeted at the formal sector. We propose and show a new lighthouse effect, where tax kinks are a reference point for wage setting in the uncovered informal sector. Results show that the minimum wage increases informal wages by 0.4%. Additionally, a hike in the first tax kink produces similar distributional effects and reduces real wages just above the revised kink of both formal and informal workers. With the informal sector’s persistence on new bunchers driving our results, we confirm that the new lighthouse effect is relevant in the case of a developing country.

We study the dynamics of formal employment, using matched employer-employee panels from ten countries at different income levels, and from across states in Brazil and Colombia. We show that increases in formality rates with development are driven by the extensive rather than the intensive margin of formal employment. Countries and regions with higher formality exhibit a higher rate of job-to-job switches and higher returns to tenure. As a result, formal workers in these regions experience higher life-cycle wage growth.