Closing the global financing gap in social protection: A middle-income countries’ perspective

Closing the social protection financing gap in middle- and low-income countries requires complex reforms. Because the preponderance of informal employment is a structural characteristic of the economies of most of them, alternative sources of financing must be found to reach people in informal employment who are not entitled to contributory social security benefits. ¹ In middle-income countries, the prevailing view is that a mix of funding sources through contributions and taxes is needed to ensure universal social protection floors and improve income distribution. But it must be recognized that informality itself is an obstacle to tax collection. However, policy innovations in middle-income countries have developed viable ways of financing the extension of social security coverage under conditions of extensive informal employment. How sources of financing are articulated depends on the type of benefit and the country in question. For low-income countries, the situation is much more challenging.

Middle-income countries have two ways of organizing the financing of coverage for the population without access to contributory social security (or with insufficient income): the allocation of public funds (mainly from taxation) or cross-subsidies from formal workers combined, implicitly, with public funds.

In the first case (explicit budget financing), there have been abundant experiences with non-contributory pensions during the last two decades. At least 19 countries in Latin America and the Caribbean have introduced a program of this type (Casalí et al., 2022). ² Also worth mentioning are income transfer programs for working-age people during the COVID-19 emergency and child benefits initiatives. The latter have been increasingly important in many Latin American countries, with Conditional Transfer Programmes in some localities in Brazil in 1995 and the Education, Health and Food Program (PROGRESA) in Mexico in 1997. These programs have been very important in improving the situation of families without children, but they are hardly enough to lift them out of poverty if they do not have another source of income (Cecchini and Atuesta, 2017). Although very different, tax-financed universal health services coverage should also be considered as a policy to close coverage gaps in social protection.

Even if somewhat different in their objective and organization, mention should be made of countries where social protection coverage of certain groups of workers is temporarily promoted through subsidized employment programs. This is the case of Uruguay, where the ‘Employment promotion programs in the private sector’ provide state support for the labor inclusion of vulnerable groups with incentives and subsidies for paid employment for young people. Tunisia incorporated a similar scheme under the Investment Incentives Code to recruit Tunisian first-time jobseekers, and Turkiye has subsidies for employment in some specific locations in the country. These initiatives are effective to the extent that they are accompanied by additional measures to encourage and allow the full formalization of the participant workers. The eventual permanence of the subsidies beyond a reasonable period to promote the formalization of workers may, however, be fiscally unsustainable (Calligaro and Cetrángolo, 2023).

Likewise, there are numerous cases where the expansion of coverage combines budgetary resources with cross-subsidies from formal workers. Many times, it is about supporting the inclusion of specific groups of workers. Examples of this are found in the Brazilian rural pension scheme, where some categories of rural workers for which different contribution rules are established but have access to the same benefits as those under the General Social Welfare Scheme. For its part, in Ecuador, agricultural workers’ social protection is partially financed through cross-subsidization by employers and employees registered in the general insurance scheme and though a state subsidy.

The so-called Monotributo (Monotax) is an innovative initiative developed in Argentina, Brazil, and Uruguay. It is a simplified, integrated tax regime that replaces, with a fixed monthly fee, the payment of different taxes (income, VAT, and others, depending on the case) and contributions for social security (pensions and health in Uruguay and Argentina but only pensions in Brazil). The Monotax regime is aimed at small taxpayers, be they independent workers or micro-entrepreneurs. As the contribution to this scheme is usually much lower than that required to finance the benefits they potentially receive, it involves a cross-subsidy from formal workers, generally complemented with budgetary resources (Cetrángolo et al., 2018).

One issue with schemes that include cross-financing from formal workers is that they can generate negative incentives to formalize work and encourage a view of social security contributions as taxes, and regressive ones at that. For this reason, they are not recommended. When contributions are not enough to ensure universal and sufficient coverage of social protection, it is essential to provide additional tax financing to avoid potential social resentment and encourage compliance. Innovative solutions are required to steer governments away from regressive forms of taxation to fund social security.

Given the political and administrative difficulties in collecting taxes on personal income and assets, many countries resort to regressive consumption taxes aggravating inequality. In middle-income countries with high evasion and weak collection of income and property taxes, reforms in tax policy and administration are required to achieve resources that improve income distribution and finance increased spending on social protection. This is the case of many Latin American and Caribbean countries where, on average, personal income tax collection is barely 2% of GDP (less than 10% of total tax collection) (Cetrángolo et al., 2023).

But this is not the case in low-income countries, where the financing gap is so large that must be considered a global problem (Cattaneo et al., 2024; see also Razavi – this edition), demanding innovative yet robust social protection financing mechanisms based on global solidarity.