Income-shifting between income sources - Evidence for Uruguay from administrative tax records in the period 2009-2014 - ECINEQ
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Income-shifting between income sources.
Evidence for Uruguay from administrative tax records in the
period 2009-2014.
Eliana Sena, Matı́as Strehl∗
Tutor: Marcelo Bérgolo
Facultad de Ciencias Económicas y de Administración
Universidad de la República
Society for the Study of Economic Inequality
January 2019
Abstract
This study examines income-shifting between income sources among the firm’s
owners that receives dividends in Uruguay for the period 2009-2014. The dual in-
come tax system in Uruguay offers noticeable incentives for income-shifting between
wages and dividends for business owners. Our data set comes from administrative tax
records of the Uruguayan Tax Administration, which allows a characterization of the
population that receives dividends. In order to describe the extent of income-shifting
we estimate a cross-sectional equation finding a coefficient of 0.516, which represents
a moderate effect in relation to the international literature. The tax reform of 2012
enables us to study how this particular form of tax avoidance reacts to an exogenous
change in tax rates. Using a first differences equation, we find moderate and sta-
tistically not significant responses. Hence, we conclude that income-shifting between
wages and dividends does not seem to be an extended practice among business owners
in Uruguay. This results could be explained by the low number of individuals that
receives nominative dividends, and also by the existence of owners that do not receive
dividends, who are not considered in this study. In addition, these individuals may
have different considerations when composing their income, such as preferences for
social security and health care. Finally, it could be explained by other tax avoidance
mechanisms that are not considered in this study, such as partner’s accounts.
Key words: business owners, income-shifting, personal income taxes, tax incentives.
JEL classifications: H24, H26, O12
∗
Acknowledgments: We would like to thank, in the first place, our tutor Marcelo Bérgolo for his constant
support, time and dedication in this process. To the professors, Andrea Vigorito and Jorge Campanella,
for their guidance and comments. To Joan Vilá for his collaboration with the database and his enriching
contributions. To Felipe Berrutti for his valuable comments. To Rodrigo Lluberas, for his time and critical
comments during the presentation of this work. Finally, to our closest environment for support.Page
1 Introduction 1
2 Literature review 4
2.1 Empirical evidence of income-shifting to dual tax income system . . . . . . 4
3 Theoretical framework 5
4 Institutional background 6
4.1 Capital income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
4.2 Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
4.3 The wage tax reform of 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . 7
4.4 Tax incentives to income-shifting . . . . . . . . . . . . . . . . . . . . . . . . 8
5 Data 11
5.1 Tax payers information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5.2 Database construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5.3 Data limitations and additional assumptions . . . . . . . . . . . . . . . . . . 11
6 Empirical strategy 12
6.1 Optimization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
6.2 Econometric models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
6.2.1 Cross-section analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 13
6.2.2 Panel data analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
7 Results 15
7.1 Descriptive analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
7.1.1 Comparison between business owners and wage earners . . . . . . . 15
7.1.2 Comparison among business owners . . . . . . . . . . . . . . . . . . 17
7.2 Optimization results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
7.3 Optimizing behaviour: econometric analysis . . . . . . . . . . . . . . . . . . 20
7.3.1 Non parametric evidence . . . . . . . . . . . . . . . . . . . . . . . . 20
7.3.2 Parametric evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
7.3.3 Heterogeneity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
7.4 Responses to 2012 tax reform . . . . . . . . . . . . . . . . . . . . . . . . . . 26
7.4.1 Non parametric evidence . . . . . . . . . . . . . . . . . . . . . . . . 26
7.4.2 Parametric evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
8 Robustness 28
9 Final comments 30
10 References 31
A Tablas y figuras 34
B Sistema de seguridad social 36C Metodologı́a del cálculo del proceso optimizador impositivo 37 C.1 Primer grupo de Naturalezas Jurı́dicas . . . . . . . . . . . . . . . . . . . . . 37 C.2 Segundo grupo de Naturalezas Jurı́dicas . . . . . . . . . . . . . . . . . . . . 39 C.3 Tercer grupo de Naturalezas Jurı́dicas . . . . . . . . . . . . . . . . . . . . . 42
List of Tables
1 Marginal tax rates on wages evolution (IRPF II) 2008-2012 . . . . . . . . . 7
2 Preliminary statistics from dataset . . . . . . . . . . . . . . . . . . . . . . . 12
3 Descriptive statistics of the comparison of business owners vs wage earners 16
4 Descriptive statistics of the comparison of business owners if they combine
their income at least once or not. . . . . . . . . . . . . . . . . . . . . . . . . 18
5 Number of time that each business owners group receive income, separated
by sources. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
6 Composition according to the legal nature of the firm . . . . . . . . . . . . 19
7 Composition according to income level . . . . . . . . . . . . . . . . . . . . . 20
8 Estimation of extent of income-shifting for the pool of data . . . . . . . . . 22
9 Heterogeneity estimations of the extent of income-shifting for the pool of
2009-2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
10 Estimation of income-shifting responses to changes in tax schedule. . . . . . 28
11 Estimation of extent income-shifting for pool of data from 2009 to 2012,
including variable controls of size firm. . . . . . . . . . . . . . . . . . . . . . 29
12 Estimation of income-shifting responses for changes in economics incentives,
considering individuals with incentive changes. . . . . . . . . . . . . . . . . 30
13 Evolución de las deducciones del IRPF categorı́a II (2008-2012) . . . . . . . 34
14 Distribución de actividades de los dueños de empresas . . . . . . . . . . . . 34
15 Dueños de empresas con ingreso positivo para cada año según grupos: no
combinan, combinan, considerados en la optimización . . . . . . . . . . . . 35
16 Estadı́sticas descriptivas de los dueños de empresas para tres grupos: no
combinan ingreso, combinan ingreso y ppoblación de la optimización . . . . 36
List of Figures
1 Marginal tax raxtes of IRPF: 2011 and 2014 . . . . . . . . . . . . . . . . . . 8
2 Marginal tax rates of IRPF according to legal nature of the firm (2014) . . 10
3 Average number of firms for which business owners and wage earners receive
income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
4 Number of business owners that receive dividends and/or wage by year. . . 17
5 Difference between realized gross wage and tax-optimal wage, 2009-2014 . . 21
6 Estimation of income-shifting extent for each year(2009-2014) . . . . . . . . 23
7 Difference between realized gross wage and tax-optimal wage: 2011 vs 2014. 27
8 Fuente de ingreso de los dueños para cada año, según combinen o no su
ingreso al menos una vez en el perı́odo . . . . . . . . . . . . . . . . . . . . . 351 Introduction
Understand the individual responses to tax changes is central to the correct design of
public policies. This responses has been the object of study of numerous works of public
economic. Until 90s, the efforts were in estimating the reaction of labor supply, effort and
savings to tax changes, known as real responses. The objective was to measure efficiency
losses derived from tax chances. However, those research did not take into account that
tax changes can bring with them other behavioural changes, such as tax avoidance or tax
evasion (Saez et al., 2012; Feldstein, 1995; Gordon and Slemrod, 2000).
As every responses to tax changes could be considered efficiency losses, estimate only real
respones does not reflect the real impact of changes in marginal tax rates (Saez et al.,
2012). Estimate the true responses to tax changes is important because it allows to define
the correct design of public policies (Saez et al., 2012). This literature has recently began
to measure responses in terms of taxable income, specifically through the calculus of his
elasticity (ETI). The first works sought to estimate these elasticities taking into account
the total response in the reported income (Feldstein, 1995, 1999). However, recently some
works theoretically show that the different responses in the taxable income have different
implications of efficiency and well-being, so that this responses are disaggregated consider-
ing evasion and avoidance. Despite these precisions, all the works find that the elasticities
derived from considering taxable income responses to changes in the incentives, are sub-
stantially greater than those derived from consider only real responses, so that a large part
of the responses to tax changes is due to tax avoidance and tax evasion.(Feldstein, 1995,
1999; Chetty, 2009; Saez et al., 2012; Weber, 2014; Saez, 2017).
One non real responses to tax changes consist on the process of switch income between
sources, countries, tax bases, moments, among others. This process is known as income-
shifting and is one of the most relevant ways of tax avoidance, especially among business
owners and high income individuals (Goolsbee, 2000; Harju and Matikka, 2016b). It is
motivated by tax changes and do not represent changes in level income. For instance, a
reduction in wages after an increase in wage marginal tax rates could be explained by a
reduction in labor supply (real responses), and also by a switch of income from wage to
dividends (income-shifting) (Alstadsæter and Jacob, 2016; Gordon and Slemrod, 2000).
The extend use of income-shifting as several implications. In the first place, can generate
efficiency losses. Additionally, income-shifting can cause problems of measuring personal
inequality. Business owners and high-income individuals can reduce their salary income
by transferring a portion, for example, to dividends. The reduction of the consequent
personal income inequality does not represent what happened in reality, by not consider-
ing the possibility of reclassifying the income (Gordon and Slemrod, 2000; Slemrod, 1995).
In turn, this process involves problems of vertical equity between employees and business
owners, self-employed workers or managers, who are the most likely to have access to these
strategies. While workers who only receive wages have few opportunities to participate in
this type of practice 1 , The owners of companies can choose how they report their own
benefit (Harju and Matikka, 2016a). Additionally, it can generate problems of horizontal
inequity because, at the same level of income, access to these practices depends, among
1
managers do not always have the possibility to choose the composition of their income, since it is
ultimately the company’s decision.
1other reasons, on the bargaining power and participation in the company’s ownership of
the firm. Those who have a high share in the ownership of the firm are more likely to
adjust the composition of income in line with the tax incentives (Alstadsæter and Jacob,
2016).
For all these implications, the study of income-shifting is relevant. It is particularly impor-
tant in dual income tax system, in where wage marginal tax rates and dividends marginal
tax rates differ significant one from other (Harju and Matikka, 2016a). To contribute to
the literature that studies income-shifting in dual income tax system, this paper is based
on tax system of Uruguay. Since 2007 we have a dual income tax system (Impuesto a la
Renta de las Personas Fı́sicas (IRPF)), which tax differently wages from dividends and
allows the study of behavioral responses through income-shifting of those individuals that
are capable of perceiving their income for both sources.
The works has three main objectives. In the first place, make a description of the char-
acteristics of the individuals that receives dividends -from now on “business owners”2 -
seeking to understand this population little studied in our country and its differences with
those who only perceive wages. Secondly, provide evidence of the extent of income-shifting
and analyse if the income composition of business owners in Uruguay is tax-optimal in or-
der to reduce tax payments. Finally, we want to study how taxpayers respond to changes
in economics incentives, for that we exploit the wage tax reform of 2012 in Uruguay. This
reform imply an exogenous variation of wage tax marginal rate, which allows us to deter-
mine causal responses to tax changes.
Our data comes from administrative records from the Uruguayan tax administration
(DGI). This data contain information about wages and nominative dividends of every
taxpayer in Uruguay. Additionally, unlike most jobs that study income-shifting, there
are personal and firm characteristics that are key to determining the income of business
owners (Harju and Matikka, 2016b). It should be noted that the database does not allow
us to identify those business owners who do not receive dividends.
For the first objective we made a descriptive analysis. By comparing business owners with
the rest of taxpayers we conclude that business owners in Uruguay have distinctive char-
acteristics from the rest of taxpayers -from now on “wage earners”-. On average, business
owners are richer and have a greater proportion of men than wage earners. Additionally,
while wage earners have lower activity levels3 .
On the other hand, to estimate the extent of income-shifting we made a simulation of
tax-optimal wage in order to reduce tax payments. After that we made cross-sectional
estimations, comparing realized gross wage with tax-optimal wage. Our results indicate
that the magnitude of income-shifting is 0.516, lower than the values found in the interna-
tional literature. Additionally, unlike what was found in previous studies, the individuals
with the greatest incentives to combine the composition of their income between sources
do not seem to be those who practice income-shifting to a greater extent.
Finally, to study the responses in income-shifting to tax changes we exploited the 2012
2
Although not everyone who receive dividend are business owners, our database does not allows us to
identify them (see Section 5.3).
3
In this work if an individual has positive income it is say to have positive activity.
2tax reform. This reform increase wage tax marginal rates for high income, which implies
an incentive to transfer income from this source towards dividends, specially among high
income business owners. We estimate a first differences model that analyzes how much
of the change observed in the wages is explained by the changes in the tax incentives. It
is found that the coefficient of interest is not statistically significant. This would seem
to indicate that individuals do not respond to tax changes by reclassifying their income
between salaries and dividends in order to minimize tax payments. That is to say, that
the income-shifting between sources of personal income does not seem to be a practice
very used in Uruguay.
This work is related with international literature that tries to estimate the size of income-
shifting, and the responses to tax changes through this practice. According to international
literature, income-shifting between tax bases in dual tax income system is an extended
practice (Alstadsæter and Jacob, 2016; Harju and Matikka, 2016a; Fjaerli et al., 2001;
Pirttilä and Selin, 2011). Additionally, income-shifting responses are heterogeneous among
different groups, being particularly important for those individuals with greater incentives
and opportunities to perform it (Alstadsæter and Jacob, 2016; Harju and Matikka, 2016a;
Pirttilä and Selin, 2011).
While previous mentioned works analyse income-shifting to developed countries, this pa-
per is made for a developing country. This issue has been scarcely addressed in this type
of countries, which have lower levels of application of their tax rules. In addition, it is
expected that in developing countries individuals have greater margins to transfer income
between sources, due to more lax tax systems (Besley and Persson, 2013). However, the
present work arrives to a lower magnitude of income-shifting than international literature
-0.516 compared to 1 for international literature (Harju and Matikka, 2016a)-, beside no
responses to tax changes. This could indicate that business owners in Uruguay do not do
income-shifting between tax bases. This can be attributed to characteristics of developing
countries, such as higher adjustment costs or lower tax optimization learning processes
in relatively recent systems for these countries; to carry out a transfer of income among
other sources of income not considered in this work; or tax rules that allow other types of
tax avoidance or tax evasion practices.
Additionally, the present work contributes to the national literature of public economics
since the subject has been little studied in Uruguay, especially because tax records are
recent. This topic has been study only for De Rosa et al. (2017). In that work, the authors
had the objective of study the evolution of functional income distribution and the relation
with personal inequality for years 2009-2012.
De Rosa et al. (2017) find that only a small number of national firms (2.58 % in 2012)
register business owners or partners that withdraw dividends annually. They find, in turn,
that those who withdrew dividends, when they did, generally decreased their wages, in-
dicating a potential strategic management of both sources of income. The present work
considers one of its specific objectives the exhaustive study of the characteristics of the
business owners of firms, reason why it will allow a greater deepening in the understanding
of this population.
Additionally, this work is the first in the national literature that tries to determine the
extent of income-shifting. It is the first national study supported by a theoretical model
3of income-shifting, which contains a clear prediction of the mechanisms of this practice.
Additionally, this theory offers the possibility of carry out an empirical analysis, by means
of an econometric method. In addition, it is also the first to develop a calculation method
that allows identifying for each individual the optimal composition of their income between
sources. Finally, it is important to highlight that having a characterization and a measure
of the behavior of these individuals with respect to the composition of their income, can
be used as input for the design of public policies.
The rest of the paper is organized as follows: in Section 2 we do a literature review.
Sección 3 depicts the theoretical background for our empirical anlysis. Section 4 presents
the institutional background of Uruguay. The next Section describe the database used.
In Section 6 we present the empirical strategy. Section 7 shows our results. In section 8
we present robustness check. Finally, Section 9 is dedicated to final comments.
2 Literature review
In this section we made a literature review of the empirical studies that has estimate the
extent of income-shifting in dual tax income system. The majority of works tries to es-
timate responses of income-shifting to tax changes, that generate exogenous variation in
economics incentives. Most of previous papers use panel data from administrative records
and first differences of differences-in-differences methodologies .
Previous studies face numerous problems such as measurement errors, low number of
observations of high income or absence of panel data (Goolsbee, 2000). At the same time,
results differ from one study to another (Eissa and Giertz, 2006).
2.1 Empirical evidence of income-shifting to dual tax income system
Recent literature has begun to focus more and more on taxable income responses in dual
tax systems, first established in the Nordic countries at the beginning of the 1990s, and
then expanded to other economies (Sørensen, 2005). However, this literature is still incip-
ient (Alstadsæter and Jacob, 2016).
While Fjaerli et al. (2001) estimates the magnitude of income-shifting for Norway through
a cross-sectional study for 1991, between the observed salary and the salary that mini-
mizes tax contributions, the rest of the reviewed works use panel data and differences in
differences methodologies (Alstadsæter and Jacob (2016) for the Swedish case) or a model
of first differences (Pirttilä and Selin (2011); Harju and Matikka (2016a) for the Finnish
case). In general, they find that decisions about the composition of income are strongly
motivated by the minimization of tax payments (Fjaerli et al., 2001; Pirttilä and Selin,
2011; Harju and Matikka, 2016a; Alstadsæter and Jacob, 2016).
It should be noted that those studies that study the effects of the implementation of dual
systems find that, as a result, individuals do not react by increasing their total income at
all. Instead, business owners reclassify part of their labor income as income from profits
(Pirttilä and Selin, 2011; Alstadsæter and Jacob, 2016). This decreases the efficiency gain
sought by the reforms, through the unexpected loss of revenue caused by the income-
shifting (Pirttilä and Selin, 2011; Alstadsæter et al., 2017).
4Additionally, as mentioned above, the papers find that the responses of income-shifting
are heterogeneous for different groups. They are particularly important in those individu-
als with greater incentives (Alstadsæter and Jacob, 2016; Harju and Matikka, 2016a), and
with greater opportunities to carry out the transfer of income between sources (Pirttilä
and Selin, 2011; Alstadsæter and Jacob, 2016).
However, not all studies are so conclusive in their results. Fjaerli et al. (2001) conclude
that the decision of the composition of income between sources is not only a matter of tax
minimization. There are other reasons, such as, for example, the right to obtain social
security benefits -which would motivate individuals to obtain higher income via salary-,
not contemplated in other jobs and that affect the income composition decisions.
Of particular relevance for the present study is the work done by Harju and Matikka
(2016a). The authors make an empirical approach where they study the income-shifting
between sources of income for owners of private companies in Finland, which since 1993
applies a dual tax system for personal income. The authors analyze how widespread
and how significant income-shifting is between income sources and how business owners
respond to changes in incentives. For this, they exploit the 2005 reform that, based on
legal modifications that prevented double taxation of dividends, increased the marginal
rates that could be taxed on profits in large quantities -for the case of some owners,
the increase in these rates was from 29% to 40.5% -. This generated an increase in the
incentives to receive personal compensation in the form of salary. Using a cross-section
analysis from 2002 to 2008, they estimate the magnitude of income-shifting. They find a
significant correlation that varies between 0.9 and 1.05. On the other hand, by means of
the first difference of the previous analysis, they estimate the response of income-shifting
to changes in tax incentives, finding a significant effect of 0.66. This result implies an
important but not “perfect” response.
3 Theoretical framework
This paper is based on the previous work of Harju and Matikka (2016a). This model
focuses on the ability of business owners to choose an optimal combination of salaries
and profits in order to minimize personal tax contributions. In this sense, it allows us to
compare if the decisions of business owners are optimal and if changes in the tax systems
produce responses for income-shifting.
The aim of business owners is to maximize their utility which depends positively of their
income after taxes - composed of salaries (W ) and dividends (D). Their utility decreases
with the costs related to income-shifting (γ). The budget restriction of the business owners
depends on the total income from the firm before taxes Π and the retained earnings (R).
We asume that the business owners are responsible for the relevant decision of business
benefit distribution.
The owners optimization problem is to:
max: U (W + D, γ) = (1 − tw )(W̃ g − γ) + (1 − td )(D̃g + γ) − φ(γ) (1)
g g
sujeto a: Π − R = W + D (2)
Where W̃ g y D̃g are wage and dividend income, if the owner do not do income-shifting.
5son los ingresos por salarios y utilidades en ausencia de posibilidades de realizar income-
shifting, (W̃ g − γ) = W g es el salario observado bruto, y (D̃g + γ) = Dg son las utilidades
observadas brutas. Por otra parte, tw = tw (W g , Dg , I) y td = td (W g , Dg , I) son las tasas
promedio de impuestos a los salarios y utilidades respectivamente. Ambas están entre cero
y uno y dependen del salario y las utilidades brutas y de I, que es el ingreso ganado fuera
de la firma. A su vez, φ(γ) el costo del income-shifting. En la restricción, Π representa
los beneficios brutos de la empresa, R las ganancias retenidas, y su diferencia es lo que
el dueño percibe como ingresos personales . Finalmente, se asume por simplicidad que el
costo del income-shifting es convexo y suavizado, y que φ(0) = 0.
The model focus in the income-shifting responses with given total income. To simplify
the model, Harju and Matikka (2016a) assume that W̃g and D̃g are constant. Through
taking the first*order condition with respect to γ it is possible to obtain the optimal
income-shifting responses:
∂tw ∂td
tw + − td + = φ0 (γ) (3)
∂γ ∂γ
This equation implies that the combination between wages and dividends is tax-optimal
when the difference between wage marginal tax rate tw + ∂t ∂γ = M T RW and dividend
w
marginal tax rates td + ∂t
∂γ = M T RD , equals the marginal cost of income-shifting. In
d
the margin, we assume that marginal cost of income-shifting is zero, and hence, the tax-
optimal condition is simply:
M T RW = M T RD (4)
To minimice tax payments, business owners adjust γ until marginal tax rates equals. The
tax-optimal combination of wages and dividend it is known as (W ∗ , D∗ ).
This model allows an intuitive approach to the costs of income-shifting. If business owners
chose their income respecting the equation 4 - which implies that (W g , Dg ) = (W ∗ , D∗ )-,
that would mean both, a high responses of income-shifting to tax changes, and a low
marginal cost for doing it.
Finally, it should be noted that although this model allows us to approximate the intuition
that lies behind the behavior of business owners, some of the assumptions made do not
- generally - hold in practice. First, the marginal tax rates are smooth and continuous -
which avoids the existence of corner solutions where W g or Dg can be equal to zero. In
fact, corner solutions can be an optimal solution. Second, some owners may make opti-
mization errors. Finally, the marginal rates may not equal, as in the Uruguayan case, so
the optimization may not be perfect.
The present work takes from this model the maximizing behavior of utility of the owners,
through the equalization of the marginal rates, with the objective of reaching the optimal
combination of income that minimize tax payments, in order to approach the way in which
they are effectively taken this type of decisions in Uruguay.
4 Institutional background
Since July 2007 Uruguay has applied dual income taxation trough the creation of the
”Impuesto a la Renta de las Personas Fı́sicas” (IRPF). According to this tax, earned
6income is taxed at a progressive tax rate schedule, while personal capital income is taxed
at a flat tax rate. It is an annual, personal and direct tax. This tax implied a profound
change due to that, in the first place, capital income was taxed, and also because it
introduced a dual income taxation system.
4.1 Capital income
The first category of IRPF taxes a variety of personal capital income. Due to the fact
that we will focus in the income-shifting between wage income and dividen income, in this
paper we consider only the dividends of business owners which are taxed at a flat tax rate
of 7%.
4.2 Wages
The second category of IRPF considers the rents derive from work (wages). Wages are
subject to a progressive tax rate schedule based on “Base de Prestacion y Contribuciones”
-BPC, $1.775 in 2008, USD 55). Also, the wages has a minimum exemption threshold and
a deduction system. (See Table 1).
There is a tax deduction system which includes pension and health insurance contribution,
expenses in education, food, rent, among others. Wage tax deduction are also subject to
a progressive tax rate schedule (See Table 13 of the Appendix).
Additionally, in 2007 it is established that taxpayers of IRPF II has the option of tribute
corporate taxes for wage income, if wage income has not been earned under a employment
relationship. Once chosen this option, the individual must stay in that tax regimen for a
minimum of three years.
4.3 The wage tax reform of 2012
Although dividend taxes has not change since IRPF creation, this has not been the case
for the wage taxes. Particularly, in our period there was a reform in 2012. That reform
imply modification in higher income levels. This is relevant because high income are those
who had greater opportunities of manipulated income composition than those of lower
income (Eissa and Giertz, 2006). Table 1 shows IRPF II differences between 2008 -year
post the tax implementation- and 20124 .
Table 1: Marginal tax rates on wages evolution (IRPF II) 2008-2012
2008 2012
Annual gross income Wage tax marginal rates Annual gross income Wage tax marginal rates
Until non-taxable minimum (NTM) of 60 BPC Exempt Until non-taxable minimum of 84 BPC Exempt
More of NTM, until 120 BPC 10% More of NTM, until 120 BPC 10%
More of 120 BPC, until 180 BPC 15% More of 120 BPC until 180 BPC 15%
More of 180 BPC, until 600 BPC 20% More of 180 BPC, until 600 BPC 20%
More of 600 BPC, until 1200 BPC 22% More of 600 BPC, until 900 BPC 22%
More of 900 BPC, until 1380 BPC 25%
More of 1200 BPC 25%
More of 1380 BPC 30%
Source: Own elaboration from the data provided by DGI.
4
In 2009 Non-taxable minimum changes, that change do not affect the results of this paper because
covers the entire period.
74.4 Tax incentives to income-shifting
The objective of this Section is to make explicit the marginal tax rates for each source
of income and for the different legal nature of firms. From the theoretical framework of
Section 3 we can say that those marginal tax rates are what determines different economics
incentives. For that reason, those marginal tax rates should been taken into account for
income composition.
The Figure 1 presents the dividends marginal tax rates -IRPF I, dotted line- and the
wage marginal tax rates -IRPF II- for 2011 -year prior to the reform, line with dots- and
2014 -year after the reform, continuous line-, without taking deductions into account. The
selection of those years responses to the objective of this paper of analyse the effect of
chances in income-shifting incentives.5 In Figure 1 we can see the break in wage marginal
tax rate for high income, occasioned by the 2012 reform. In the case of capital income,
the marginal tax rate has remained unchanged at 30.25% (dotted line).6
Figure 1: Marginal tax raxtes of IRPF: 2011 and 2014
5 10 15 20 25 30 35 40 45 50
Tasa marginal
0
0 1000000 2000000 3000000 4000000 5000000
Ingreso anual
Tasa marginal IRPF II 2011
Tasa marginal IRPF II 2014
Tasa marginal IRPFI
Source: Own elaboration from the data provided by DGI.
Additionally, contributions to social security scheme in Uruguay differs according to the
legal nature of the firms. In that way, wage marginal tax rates are different depending on
the natural legal of the firm, which makes that the optimal composition of income differs
relies on the legal nature of the business owners own. The Figure 2 presents the marginal
tax rates for wages and dividends for each type of firm legal nature. To construction of
the wages marginal tax rates include the IRPF II and the pension and social health in-
surance contributions that do not represent stranded costs7 . The dividends marginal tax
5
Since 2011 the health insurance contributions stared to have an upper thresholds, which arise the
incentive of perceiving wages. For that reason, although it would have been preferred used 2010 in order
to avoid overtaking effects, 2011 is the year that we use. At the same time, we chose 2014 for being the
furthest year for which we have information.
6
That results of considering the 25% that must be paied as company tax (Impuesto al Resultado de
la Actividad Económica) previously of receveing dividends. On the remaining rode the business owners
apply the 7% of IRPF I.
7
We consider stranded costs the amounts that independently the source of income -wages or dividends-
must be paid to social security. Majors details of this considerations are presented in the Appendix C,
which refers to the process of tax optimization. For simplicity we impute the Second Category of Minimal
Theoretical Amount. Additionally, in the case of health insurance contributions we considered the rates
8rate (dotted line), is consider the same as the previous figure.
The Figure 2 shows more convenience in perceiving wages for the case of firms of the first
group. In every case is convenient dedicate a portion of the income to wages. When income
arise, it is more convenient perceiving higher proportions of income trhough dividends (for
groups 2 and 3). Additionally, due to the fact that the reform affect all individuals the
same, it is not expected that incentives change differently among individuals depending
on the legal nature of their firm. However, there could be different incentives if there is a
correlation between legal nature and income.
corresponding to workers without children or spouses in charge.
9Figure 2: Marginal tax rates of IRPF according to legal nature of the firm (2014)
10 15 20 25 30 35 40 45 50
Tasa marginal
5
0
0 200000 400000 600000 800000 1000000
Ingreso anual
Tasa marginal IRPF II Tasa marginal IRPF I
(a) Group 1
10 15 20 25 30 35 40 45 50
Tasa marginal
5
0
0 200000 400000 600000 800000 1000000
Ingreso anual
Tasa marginal IRPF II Tasa marginal IRPF I
(b) Group 2
10 15 20 25 30 35 40 45 50
Tasa marginal
5
0
0 200000 400000 600000 800000 1000000
Ingreso anual
Tasa marginal IRPF II Tasa marginal IRPF I
(c) Group 3
Source: Own elaboration from the data provided by DGI.
Note: Groups of legal nature corresponding to similar ways of taxation (Appendix B).
105 Data
5.1 Tax payers information
Our data set comes from the Uruguayan Tax Administration and it includes information
on the financial statements and tax record of Uruguayan business and taxpayers for the
years 2009-2014. The data contain important tax information for the income-shifting anal-
ysis. For all taxpayers we have information of total amount of wage earn and the wages
of every firm that the taxpayer works. We also can identify the firms in which he or she
works, the legal nature of the firm and the industry, the total tax due and the deductions.
For each taxpayer there is information of capital rents, including total nominative div-
idends and the dividends received by each firm. The nominative dividends are those
associated with a person, in this case owners, partners or managers and represent approx-
imately half of total dividends (De Rosa, Vigorito and Vilá, 2017). This imply that the
total amount of dividends is bigger than the registered in the present paper. We also have
the total tax due. Finally, we have personal characteristics of taxpayers, such as sex and
age.
Additionally, we have financial statements of Uruguayan businesses for 2009 to 2012 with
the same identifier for firms than the taxpayer-level data. That allow us to match the
information of the firms with the taxpayer information. This financial statements must be
presented only in case that the company has “contabilidad suficiente” (sufficient account,
CS), it is to say, those that earn more than 4,000,000 UI (approximately USD 350,000)
each year. From the total firms, approximately 60% has CS. CS firms are over-represented
among high income workers (De Rosa, Vigorito and Vilá, 2017).
5.2 Database construction
From the taxpayers information and CS firms it is possible to construct a panel data for
2009 to 2014.
Table 2 shows total number of individuals on data base and the percentage that each year
has positive income (from here on, active individuals). We observe stable levels of active
individuals (65 - 70%). Last three columns are related to the individuals that at least
once receive dividends (7,537). The percentage of active individuals of this population
are presented in the last column, while the forth column shows the percentage that this
population is in total of taxpayers. It is important to note that to be in this group it is
necessary to have perceived dividends at least once but not necessary every year in which
the individual has positive income -even if one year the individual only receive wages-.
This population it is a small part of total taxpayers, what is consistent with previous
findings (De Rosa et al., 2017). It is also noticeable the bigger volatility in their activities
levels and a pronounced fall in the percentage of active individuals the year after the
reform (last column).
5.3 Data limitations and additional assumptions
One of the main weaknesses of the database when using administrative records is not have
the informal sector. Additionally, the firm level information takes into account only those
with CS. At the same time, the information from the financial statements are available
only for the first four years. Also we have information of nominatives dividends only, what
11Table 2: Preliminary statistics from dataset
Income receivers Dividends receivers
N % N % total %
2009 1,179,911 64.61 4,653 0.25 61.74
2010 1,166,647 63.88 5,119 0.28 73.23
2011 1,218,673 66.73 5,506 0.30 73.05
2012 1,200,642 65.74 5,732 0.31 76.05
2013 1,249,458 68.42 4,326 0.24 57.40
2014 1,275,608 69.85 4,388 0.24 58.22
Total 1,826,292 100.00 7,537 0.41 100.00
Source: Own elaboration from the data provided by DGI.
can bias the analysis indeterminately.
On the other hand, our dataset do not allow to identify if those who recieve dividends from
the firm are their owners. This is relevant to the extent that the incentives are different
depending on the position in the company -typically business owners consider the cost
that distribute dividends imply for the firm . To simplify we assume that everyone who
recieve dividends at least once in the period are business owners.
The main weakness of this assumption is that dividends withdrawn could be held by man-
agers and not necessarily by business owners. However, we assume that in such cases the
manager is a business decision maker and for that he consider the cost of the firm for
distribute dividends as own.
Additionaly, as we can not identify business owners in a precise way, there may be business
owners that only recieve wages, who are not being taken into account as owners. This
can generate ambiguos bias. If this business owners should be receviend dividends -what
they are not doing- the results obtaines are skewed upwards. However, if the optimal
behaviour for them is to recieve only wages -what tey are doing- the results of the extent
of income-shifting are being underestimated. Additionally, as it is a dataset of taxpayers,
we do not have information of business owners or partners without activity.
Finally, an additional weakness is related to those who recieve income for more than one
firm, because they could be business owners of only one of them. However, because the
tax payment is made for the total income we assume that the business owners consider
the income of all their works and not only the income of the firm that they own.
6 Empirical strategy
In this section we present the empirical strategy of this paper in order to study the ex-
tend of income-shifting between wages and dividends and the income-shifting responses to
changes in tax incentives. As we exposed in Section 3, every income business owners has
a tax-optimal wages and tax-optimal dividends (W ∗ , D∗ ). Following Harju and Matikka
(2016a), in first place it is necessary to find for each business owner the optimal income
composition -between wages and dividends- that minimize taxes.For that we elaborate a
minimizing tax function, given certain total gross income.
Once found tax-optimal wage, we compare it with realized gross wage (W g ). For that,
12initially we estimate a cross-sectional model to determine the extent of income-shifting.
After, we analyse the responses to changes in economic incentives, using 2012 wage tax
reform. We estimate a first difference model using 2011 and 2014 in our baseline analysis.
This model determine how realized gross wage respond to tax-optimal wage changes.
For all the estimation we clustering errors. In next section we describe in detail the
optimization process and the used models.
6.1 Optimization
Based on the model of Section 3, we made an optimization for each business owners, that
throws tax-optimal wages and tax-optimal dividends that minimize taxes (W ∗ , D∗ ) for
their total gross income. For that, from database, we reconstruct total gross income that
were available to distribute between wages and dividends. After we made 101 iterations.
Each one of them imply a different income composition between wage and dividends8 . For
each iteration we calculate the total taxes. The combination that minimize taxes is the
optimal income composition for the business owners.
To calculate the total taxes on dividends we consider and corporate taxes that must be
paid over the positive accounting result for receive dividends. For wages we consider the
wage taxes (IRPF II) and pension and health insurance contributions. The social security
system of Uruguay is presented in Appendix B. For this we consider separately each of
the groups of legal nature of the firms -single-owner businesses, contractual societies and
held corporations-, which have different social securities contributions.
For business owners of first category -single-business owners-, we not consider management
or social security contributions, because they are stranded costs. For business owners of
Contractual Societies, we consider management contributions that overcome the manage-
ment contributions that must be paid independently of realized gross wage. Finally, for
business owners of held corporations there are not stranded cost. For each iteration, the
difference between wage income and management contributions is taxable income to IRPF
II. Over that taxable income we calculate also pensions and health insure contributions.
A major detail of optimization process and the methodology is presented in Appendix C.
6.2 Econometric models
6.2.1 Cross-section analysis
First, to describe the extent of income-shifting we use a cross-section equation, estimated
by OLS:
g ∗
Wi,j,t = β1 × Wi,j,t + Xi + Zi,j,t + Ci + αt + εi,j,t (5)
This equation express the relationship between tax-optimal wage and realized gross wage,
g
conditional to individuals and firms characteristics. The dependent variable Wi,j,t is the
realized gross wage for individual i, from the firm j, at year t. The independent vari-
∗ ) is tax-optimal wage. We include personal characteristics invariant in time as
able (Wi,j,t
control variables, represented by Xi matrix, included as dummies in the model. We also
include firm characteristics as control variables, represented by Zj,t matrix. Ci matrix
8
The first iteration imply receive 0% of income through dividends, the second iteration imply receive
1% of income through dividends. Last iteration imply receive 100% of income through dividends.
13represents unobserved characteristics invariant in time that affect the realized gross wage,
such as the ability of business owner. Finally we include a temporary trend (αt ) and an
error term (εi,j,t ).
The analysis is made considering the wage, not dividends, as the relevant variable of the
optimization problem. This is because, in the first place, if business owners receive tax-
optimal wages (W ∗ ), they are also receiving tax-optimal dividends (Harju and Matikka,
2016a). Additional, profits are more affected for economic cycles, unobserved character-
istics of the firm or deferred earning perception than wages. This is specially true for
dividends, so it is preferable the estimation of income-shifting based on wage income
(Gordon and Slemrod, 2000). This profit behaviour appears to be true for Uruguay, De
Rosa, Vigorito and Vilá (2017) find that profits responses to previous years. Additional,
others sources trend to confuse income-shifting with others effects. For instance, divi-
dends maybe must be dividend among a greater number of partners, or could depend on
more rigid factors such as company participation. The wage is more flexible (Gordon and
Slemrod, 2000).
In equation (5), coefficient β1 reflects the correlation between realized gross wage and tax-
optimal wage, representing the extent of income-shifting. If β1 equals one, the realized
gross wage is perfectly correlated to optimal tax wage, which indicates that taxpayers com-
pose their income optimally -given the economics incentives of tax schedule-. Additionally
we make robustness checks for different specification of control variables, considering the
available information.
However, β1 should not be interpreted as a casual correlation between tax-optimal wage
and realized gross wage. Time-invariant variables of Ci , that affects income-shifting are
unobserved, turning them over the error term. (Which violets the exogeneity condition
∗ ,ε
cov(Wi,j,t i,j,t ) = 0 (Harju and Matikka, 2016a). For that reason, this equation is ad-
equate to determine the extent of income-shifting but not to analyse the responses to
incentive changes.
6.2.2 Panel data analysis
To estimate income-shifting response to changes in incentives, and get closer to a casual
link, we use panel data and exogenous changes in incentives created by the wage tax reform
of 2012. This reform increase wage marginal tax rates for high incomes, while dividend
marginal tax rate stay unchanged. That generate incentive to change income from wages
to dividends. To study this response, we estimate a fist difference model, usual in the
literature of income-shifting. We include the difference between t and t + w of tax-optimal
wages as dependent variable - which represents the changes in income-shifting incentives
- and the difference between t and t + w of realized gross wage as independent variable.
In this first-differences model, the time-invariant variables of matrix Ci gets canceled. This
model eliminate part of the endogeneity that could cause such variables. We use as control
variable first differences of time-variant characteristics of the firm. However, variation in
tax-optimal wage (∆W ∗ ) is affected not only for the tax reform, but also for changes in
total gross income. In order to solution the bias for relevant variable omission, we incor-
porate the income and a function of his evolution as proxy of the unobserved (Pirttilä and
Selin, 2011; Harju and Matikka, 2016a). Following Pirttilä and Selin (2011), we assume a
linear trend in the income evolution, using as control variable 2011 total gross income. In
14this way, changes in (∆W ∗ ) are due to changes in tax reform.
In this case, β2 is the average effect of a change in tax-optimal wages on the change on
realized gross wages, conditional to total gross income for both moments. β2 shows how a
change of one peso in tax-optimal wage affects, on average, realized gross wages.
g g ∗ ∗
Wi,j,t+w − Wi,j,t =(αt+w − αt ) + β2 × (Wi,j,t+w − Wi,j,t )
+ (Zi,j,t+w − Zi,j,t ) + (εi,j,t+w − εi,j,t ) (6)
The testable hypotheses are the following: if changes in the tax code explains changes in
the composition of income, β2 should be positive and statistically significant. If β2 equals
one, imply that the change in realized gross wage is mostly explained by the change in
tax code. To estimate the model we use the years 2011 y 2014. although it is true that it
would have been preferable to use the year 2010 in order to avoid potential anticipation
effects, as it was mentioned before, in 2011 the health insurance contributions changes,
generation an incentive to withdraw wages. For that reason we use 2011 in our baseline
analysis.
Equation 6 could present endogeneity problems if there were time-variant unobserved
factors, which were correlated with both changes in realized gross wages and changes in
tax-optimal wages. International literature use instrumental variables to find a solution
to this potential problem.
7 Results
7.1 Descriptive analysis
The number of people who receive dividends in Uruguay is extremely low. Of the 1,826,292
who paid IRPF at least once in the period, only 7,537 receive dividends at least once. If
we consider the companies, in 2012 only the 2.58% of those whit CS share profits among
the partners (De Rosa et al., 2017). This companies are, on average, bigger -in 2012 this
companies duplicates the annual income and the average number of workers, in compari-
son with the companies that do not share profits.
In this section we show the results of the descriptive analysis, which was realize with the
objective of a better comprehension of the population that receive dividend in Uruguay. In
the first place, we present the comparison between those who receive dividends -buisness
owners- and those who only receive wage -wage earner-. After that, we contrast between
those that, having received dividends at least once in the period, received also wages the
same year, and those who do not.
7.1.1 Comparison between business owners and wage earners
In order to compare business owners with wage earners we make descriptive statistics refer
to total income and sociodemographic characteristics, which are shown in Table 3. We
work with our database as a pool of observations, considering all individuals with positive
income each year. The income are express at constant prices of 2014.
15The Table 3 shows that wage earnes earns, on average, a pre-tax income lower than the
pre-tax income of business owners. At the same tame, although in both population there
are more men than women, the proportion of men is higher among business owners than
between wage earners. Finally, wage earners are younger.
Table 3: Descriptive statistics of the comparison of business owners vs wage earners
Wage earners Business owners
(a) Annual gross income
Mean 289,869 1,851,967
Median 184,866 751,669
(b) Sex
Men proportion 54.5% 67.9%
Average income ratio
(Men/Women) 1.2817 1.5580
(c) Age
Media 40.7 54.6
Mediana 39 54
Observations 1,826,292 7,537
Source: Own elaboration from the data provided by DGI.
Note: statistics were made for the pool for 2009-2014, considering business owners with positive income.
Incomes are express at 2014 constant prices.
Additionally, it is interesting to consider if there are differences between the number of
companies for which this populations perceive income. The Figure 3 indicates that business
owners perceive income for a higher number of companies than wage earners. De Rosa,
Vigorito and Vilá (2017) find that this is particularly true for those with higher income.
Figure 3: Average number of firms for which business owners and wage earners receive
income
10%
6%
16%
16%
1 firm
2 firm
3 or more firms
74%
78%
(a) Wage earners (b) Business owners
Source: Own elaboration from the data provided by DGI.
Note: the graphs shows the average number of firms for which business owners and wage earners receive
income. We use the pool of observations. We create three categories (one firm, two firms, three or more
firms).
After considering this first differences between the both population, it is relevant to study
the income evolution of the business owners in order to identify any strategical behaviour
16from this group related with income-shifting. The Figure 4 shows the evolution of the
number of business owners that receive dividends or/and wages each year.
Figure 4: Number of business owners that receive dividends and/or wage by year.
4,000
3,000
Business owners number
2,000
1,000
0
2009 2010 2011 2012 2013 2014
Dividends Wages
Source: Own elaboration from the data provided by DGI.
Note: For each year of the period we consider the total number of business owners that receive income
through dividends and/or wages, separately.
Based on Figure 4 we can observed that approximately 3,500 business owners perceive
wages every year, while dividends are much more volatile. An interesting break occurs
after 2012 -the reform year- in which dividends fall. The next step for further researchers
is the analysis of business owners in order to understand why they react by reducing the
number of dividends after 2012. What we can say from the Figure is that apparently the
2012 reform do not affect the number of business owners that receive wages.
7.1.2 Comparison among business owners
In this section we compare business owners. Of the total number of business owners iden-
tified, a subgroup combine their income between dividends and wages at least once. This
individuals are identify by this work as those who has greater probability of doing income-
shifting. For that reason, are this individuals the ones that we consider in our estimations.
We will now include some statistics for this population in particular (“Combine”), and his
comparison to those business owners that has never combine their income between sources
(“Do not combine”).
17Table 4: Descriptive statistics of the comparison of business owners if they combine their
income at least once or not.
Combine Do not combine
(a) Annual Income
Mean 1,957,668 1,843,938
Median 887,402 607,957
Percentile 99 17,200,000 17,900,000
(b) Dividends
Mean 2,141,009 2,053,377
Median 649,546 704,918
(c) Wages
Mean 1,035,955 683,911
Median 572,168 223,461
(d) Age
Mean 51.9 58
(e) Sex
Men proportion 68.7% 66.9%
Source: Own elaboration from the data provided by DGI.
Note: Statistics were made for the pool of observation of 2009-2014. Separating between business owners
that combine their income among sources at least once (Combine), and those who do not (Do not combine).
Income is express at 2014 constant price.
Table 4 shows that business owners which combine income composition are richer, younger,
and have a greater proportion of men.
At the same time, although in the previous section we see an important volatility in
business owners activity, inside this population there are differences according to if they
combine their income or not. Those business owners that combine their income compo-
sition have less inactivity each year. Secondly, the percentage of those who combine that
receive only dividends some year is very small. For that, we can say that they are a group
that every year perceive wages, or, wages and dividends at the same time. Contrary, busi-
ness owners that do not combine are characterized by having higher inactivity rates, and
the percentage of those who receive wages is very low. According to that, we can say that
it is a group of people who principally receive their income through dividends or through
another source not considered in this work (Appendix A).
In the same line that previous analysis, an important difference is the periodicity of their
activities. Table 5 shows the amount of times that a business owners receive income,
separated by sources, for the period. As data is express annually, a business owners that
receive dividends six time has perceive dividends every year. The same happens with
wages.
For business owners that combine their income we observe that more of 50% percent
receive wage every year, while more of 80% of those who do not combine not receive wage
any year and almost half of them perceive dividends only once. Table 14 of Appendix
shows an analysis of this behaviour in more detail. This confirm that business owners that
do not combine their income are characterized by low activity levels.
18Table 5: Number of time that each business owners group receive income, separated by
sources.
Combine Do not combine
Wages Dividends Wages Dividends
0 - - 81.1% -
1 5.4% 35.1% 8.7% 44.1%
2 5.2% 29.2% 4.8% 25.0%
3 7.5% 13.3% 2.9% 14.8%
4 8.8% 11.5% 1.7% 10.4%
5 15.3% 6.0% 0.9% 3.6%
6 57.8% 4.9% - 2.2%
Total 100% 100% 100% 100%
Source: Own elaboration from the data provided by DGI.
Note: Data is expressed annually. The Table indicates the total number of years that business owner
receive wages and/or dividends. At the same time, it is separated by those who Combine their income and
those who Do not combine.
7.2 Optimization results
To made the optimization tax process describe in Section 6.1, we took the business owners
that combine their income at least once in the period. We exclude individuals of the 5%
extremes of distributions. This prevent from outliers that biases the average effects obtain
on estimations (Sivadasan and Slemrod, 2008), as we have checked. The result is a pool
of 10,579 observation for the period 2009-2014. In Table 15 and 16 of the Appendix we
present some statistics of this population, in comparison with the rest of business owners,
as well as the total of observations available for each year and group.
Although the optimization process is made for each individual every year, it is relevant
to group individuals according to different characteristics and study, on average to each
group, their incentives to combine their income composition. Legal nature are grouped on
the previously mentioned groups. Table 6 presents the distribution of observations for this
groups and also the tax-optimal wage proportion of their income. That means that, for
example, business owners of group 2 should receive, on average, 0.67 percentage of their
total gross income through wages in order to minimize their tax payments. The results
are coherent with what was exposed on section 4, where we observed that business owners
with higher incentives to combine their income between wages and salaries belong to the
second group.
Table 6: Composition according to the legal nature of the firm
Group Observation Tax-optimal wage proportion Realized wage proportion
Group 1 4.79% 1 0.88
Group 2 18.79% 0.67 0.59
Group 3 76.42% 0.47 0.79
Total 100% 0.54 0.76
Source: Own elaboration from the data provided by DGI.
Note: table presents the composition of the pool. We present, at the same time, the average income of
each group and the tax-optimal wage income proportion.
To study different incentives according to income level of business owners we identify, in
the firs place, those who do not have incentives to combine their income composition.
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