Ecuador’s Unique Tax System: A Closer Look
Overview
In Ecuador, employees in the private sector are required to pay social security contributions, which entitle them to a range of benefits including pensions, health insurance, disability insurance, and unemployment benefits. The country’s tax system is unique in its generous deduction allowances for personal expenses in education, health, food, clothing, and housing.
Tax Filing
In Ecuador, PIT is primarily filed on a firm-reported tax form (F107), which can only be submitted by the employer. Employees fill out a form with their projected expenses in health, education, food, clothing, and housing for the year and submit it to their employer. Based on these figures, the employer computes the level of withholding tax for the following year.
Additional Wage Benefits
Employees also contribute 9.45% of their wage income to social security, while employers pay an additional 11.15%. These contributions entitle workers to a range of benefits, including:
- Pensions
- Health insurance
- Disability insurance
- Unemployment benefits
Data Analysis
A recent study analyzed matched employer-employee data from 2006 to 2015 to examine the income distribution in Ecuador. The study found that a significant fraction of wage earners have multiple employers throughout the year, with some individuals employed by multiple firms at the same time.
The analysis also excluded public sector employees and focused on private sector workers. About one quarter of formal sector employees are in the public sector. The study used real 2013 USD values to adjust for inflation and considered the spell with the highest earnings as the main employer.
Income Distribution
Figure 1 displays the reported income distribution in Ecuador, pooling all observations from 2006 to 2015. The graph shows a downward-sloping distribution of gross income, with the most frequent points around the minimum wage. The marginal tax schedule is depicted by a step function on the right vertical axis.
The study found that the gross income distribution is smooth around all kink points of the marginal tax schedule, indicating that the tax system does not have a significant impact on the income distribution in Ecuador.