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Should I stay or should I go?: the economic incentives of intergenerational taxes and transfers in Uruguay

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“If I go, there will be trouble, And if I stay, it will be double”

(Should I Stay or Should I Go, The Clash, 1982)

Abstract

This paper develops a business cycle model of a small open economy with heterogeneous agents and international labor mobility, with a particular focus on taxes and transfer policies. Migration occurs as a result of the maximization problem of families and, combined with remittances, makes consumption smoothing possible. This paper shows how transfers from the government to young people and elders, funded with distortionary taxes, prompt the migration of people of working age and, among them, some of the most skilled members of the economy. The model is calibrated to match labor mobility in various age–skill groups and aggregate cycle dynamics of the Uruguayan economy, including government transfers and migration volatility.

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Fig. 1

Source: based on United Nations, population division

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Notes

  1. The global stock of migrants has grown from 153 million to 258 million people between 1990 and 2017; representing 3.4% of total population (United Nations, 2017).

  2. Hanson (2010) shows that people who migrate to OECD countries from developing countries have higher levels of education, as compared to the people that do not. Similarly, Chiquiar and Hanson (2005) find that migrants from Mexico to the USA are concentrated in the middle of the distribution in terms of education and wages.

  3. The “welfare magnet hypothesis” suggests that immigrants are more likely to move to countries where welfare systems are generous. Several studies have analyzed this hypothesis, but results are not conclusive (Giulietti, 2014). Jakubiak (2017) provides an extensive literature review on immigration and welfare systems, noticing that there is no discussion about the relationship between international migration and the redistributive policies in the countries of origin, which is the main focus of this paper.

  4. Since 2002, the Central Bank of Uruguay has included family remittances among foreign transfers in its balance of payments statistics.

  5. Greece has also shown low levels of remittances in its last migration wave. Although it appears that in this case it is related to a “brain waste” mechanism, i.e., the underemployment of migrants in the host country makes it difficult to send remittances (Lazaretou, 2016).

  6. Although expenditures rose over the past years, problems related to the extremely high dropout and repetition rates in middle and high school have not yet been solved (Casacuberta and Bucheli, 2010; Cid and Ferrés, 2010; de Armas, 2018)

  7. For example, cigarettes are taxed at 70%, some alcoholic drinks at 85%, beer at 27%, and other non-alcoholic drinks at 30%.

  8. According to the 2018 Annual Report of the Fondo de Solidaridad, 466 university graduates living abroad have received the exemption. There is no official estimate of the total number of exemptions due to this cause.

  9. As defined by Lee and Mason (2011), the life-cycle deficit is the difference between consumption and income at each age. This deficit can be funded through public or private transfers, and with public or private asset-based reallocations.

  10. Private and public asset-based reallocations could be financed with capital or natural resources, or financial assets. Capital or natural resources include land and subsoil minerals in public or private areas, as well as equipment, structures, and housing in the private sector. In the public sector, financial assets cover the debt, sovereign wealth funds, and stabilization funds. In the private sector, financial assets are in the form of consumer debt or credit, mutual funds, private pension funds, and personal savings (Lee and Mason, 2011).

  11. Heterogeneous labor is introduced using the proposal made by Kydland (1984) and subsequently applied by Garcia-Milà et al. (2010), Maliar and Maliar (2000, 2001, 2003), and Janiak and Monteiro (2010).

  12. It is equivalent to assume that there are no capital mobility problems. Leers et al. (2004) use this assumption to simplify the analysis without losing generality.

  13. This specification allows for labor adjustments along the intensive and extensive margins. The extensive margin takes into account the decision of emigrating or staying at home.

  14. Busato and Chiarini (2004), Busato et al. (2012), Orsi et al. (2014), and Annicchiarico and Cesaroni (2018) have interpreted this additional cost as capturing the lack of social and health insurance in the underground sector.

  15. Apart from its mathematical convenience, quadratic costs are relatively easy to calibrate as we treat the costs of migrating or returning symmetrically.

  16. Since the economy only produces a homogeneous consumption good, the equilibrium price vector has been normalized to (1,\(w_t\)), where \(w_t\) denotes the equilibrium real wage rate.

  17. For the application below, young people are defined as those under 25 years old, and elders as those over 59 years old. Other age groups do not have in-cash transfers.

  18. Arseneau and Chugh (2012) assume an exogenous process for total government spending.

  19. For people under 20 years of age, the skill classification is established for the head of the household.

  20. Since there is no estimation of the consumption profiles of Uruguayan migrants, it is assumed that they are the same as the ones observed for Uruguayans living in Uruguay.

  21. There is no micro-data available for Uruguayans living in Brazil.

  22. See Annicchiarico and Cesaroni (2018) for details.

  23. The model does not have unemployment. Thus, employment in the home economy (abroad) is defined as the ratio between the employed in the home economy (abroad) and the total employed (at home and abroad) plus the population outside the workforce (home and abroad).

  24. As noted by the reviewer, the share of income earned abroad and sent home is low because the model assumes that every migrant remits, and at the aggregate, must reproduce the large portion of the population living abroad and the share of remittances relative to the GDP that Uruguay receives.

  25. Table 5 shows two relevant issues of Uruguayans living abroad. Firstly, people who leave Uruguay earn, on average, a wage measured in PPP that is 2.3 times higher than the average wage earned in this country. Secondly, they remit home a low proportion of incomes generated abroad, representing only 0.5% of the GDP in the year 2006. Figure 6 from the Appendix shows the mean pre-tax wage difference between wages earned abroad and home, for the year 2006, for each age and skill group.

  26. Figure 7 presents the simulated series of the main aggregate variables of the model.

  27. Additional exercises of impulse-response functions are available upon request.

  28. The Dirección General Impositiva of Uruguay estimated that the implicit VAT tax rate generated government revenues of 10.2% of the GDP in 2012. In this model, that implies that the implicit VAT tax rate increased from 0.10 to 0.11.

  29. This scenario is referred to as “Fiscal Reform.”

  30. The scenario of increasing social spending in education is referred to as “Education” and the scenario of the increase in social security and pensions as “Pensions.”

  31. Table 13 in the Appendix reports the estimated marginal tax rates of the three analyzed scenarios.

  32. On average, the fiscal reform involved a reduction of 2% of the implied tax rate on labor incomes.

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Acknowledgements

We are grateful to the Editor-in-Chief, Sara LaLumia, and two anonymous referees for their constructive comments and suggestions, which greatly improved the quality of the paper. We thank Javier Bianchi, Serafín Frache, Álvaro García, Juan Carlos Hatchondo, Pablo Neumeyer, Christian Ruzzier, Leandro Zipitría, and the participants of the Workshop on “International Macro” organized by RIDGE, Montevideo-Uruguay 2018; the Workshop of EMIC, Santiago-Chile; and the participants to the contributed sessions of 2019 LACEA-LAMES Meeting, Puebla-Mexico. The usual disclaimer applies.

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  1. Departmento de Economía, Facultad de Ciencias Sociales, Universidad de la República, Montevideo, Uruguay

    Florencia Amábile

  2. Department of Economics, University of Chile, Santiago, Chile

    Rómulo A. Chumacero

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  1. Florencia Amábile
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Correspondence to Florencia Amábile.

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Appendix

Appendix

See Figs. 6 and 7.

Fig. 6
figure 6

Mean pre-tax wage earned from Uruguayans living abroad, relative to those Uruguayans living in Uruguay (in 2006 PPP values)

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Fig. 7
figure 7

Simulation of main variables of the model, cycle, and steady-state values

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See Tables 12 and 13.

Table 12 Correlation between GDP and participation rates at home and foreign
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Table 13 Marginal tax rates applied in the benchmark model and simulated scenarios
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Amábile, F., Chumacero, R.A. Should I stay or should I go?: the economic incentives of intergenerational taxes and transfers in Uruguay. Int Tax Public Finance 30, 493–524 (2023). https://doi.org/10.1007/s10797-021-09723-9

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