In 1990 Colombia replaced its traditional system of severance payments with a new system of severance payments savings accounts (SPSAs). Although severance payments often are justified on the grounds that they provide insurance against earnings loss, they also increase costs for employers and distort employment decisions. The impact of severance payments depends largely on how much of the costs to employers can be shifted to workers. The theoretical analysis in this paper shows that, in contrast to a traditional system of severance payments, the system of SPSAs facilitates 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 shifted around 80% of the total severance payments contributions to wages and had a positive effect on weekly hours. Results using the 1997 Colombian Living Standards Measurement Survey suggest that, although SPSAs in part replaced employer insurance with self-insurance, SPSAs continue to play a consumption smoothing role for the non-employed.
Distortions tax shifting unemployment insurance consumption smoothing crowding out