EMPLOYMENT EFFECTS OF TAX CUTS: THE CASE OF SERBIA Jelena Žarković Rakić Faculty of Economics and FREN University of Belgrade

Motivation Since 2000 Serbia experienced relatively high GDP growth rates At the same time, employment rates rather low, even negative Which factors prevent job creation in the economy?

Motivation Focus on labor taxes (labor tax wedge) Policy recommendation of the OECD Jobs Study :  "Reduce non-wage labour costs, especially in Europe, by reducing taxes on labour..."  "Reduce direct taxes (social security and income taxes) on those with low earnings SSC employers SSC employees Wage tax Net wage Labor taxes Labor costs

Tax-employment link in Serbia Arandarenko and Stanic (2006): tax wedge in Serbia accounts for about 40% of total labor costs on average

Tax-employment link in Serbia Arandarenko and Vukojevic (2008):  found rather low (short-run) elasticity of labor costs with respect to labor demand  negative. but not significant impact of labor tax wedge on employment level

Contribution Find evidence for tax-employment link at the micro level in Serbia Show that policy aimed at reducing labor taxes for workers of certain skill categories would be more favorable for employment than across-the-board-tax cuts To justify selective labor tax reductions across skill types, focus on tax-shifting phenomena

Tax shifting Tax shifting exists when legal tax incidence (i.e. who writes the check to pay a tax) differs from actual economic burden of the tax (i.e. whose real income is lowered) Increase in SSC, legally borne by employers, are passed on to workers as lower wages, or, wage increase as a result of SSC reductions

Tax shifting Gruber (1997):  large reduction in SSC was fully shifted onto higher wages with no positive effects on employment Korkeamaki and Uusitalo (2006):  increase in wages offset roughly half of the impact of the SSC cut on the labour costs Kugler and Kugler (2008):  1/5 of SSC increase was shifted onto lower wages. Less shifting for production (low-skilled) workers. Taymaz (2007):  also founds lower degree of shifting for low wage earners

Empirical model Dynamic employment equation is in the panel data form: with i=1,…,N; t=1,…,T where Nit is the number of employees in the establishment i and year t, wit is the real product wage (labor costs), kit is the capital stock and qit is the output

Empirical model The same model is estimated separately for high- skill and low-skilled workers:

Empirical model How wages respond to changes in taxation - wage equation: Coefficient of the variable stands for the ratio between employers’ social security contributions and gross wage (SSC rate); measures the level of tax- shifting number of minimum wage earners in the labor force, minimum wage and kl capital-labor ratio.

Data The sample consists of a panel of manufacturing firms observed for the period Firms classified into several industrial groupings: capital goods and consumer durables, consumer goods and intermediate products.

Estimation method All equations have dynamic form since they include lagged dependent variable on the right-hand side In case of dynamic models, standard panel estimation techniques would produce biased and inconsistent estimates Following Blundell and Bond (1998), we chose system GMM

Estimation results: total employment  Coefficient of lagged labor demand variable measures how rapidly labor demand adjust to a shock in product demand or factor prices  It takes about 1.9 years to move halfway to the eventual equilibrium employment level → low flexibility of labor market  Long run wage elasticity of → employment adjust strongly to change in labor costs ** signif. at 5%., *** signif. at 1%. Dependant variable: Employment Coefficient Employment (-1)0.774*** Output0.164** Output (-1)0.044 ** Capital0.034** Labor_costs0.102 Labor_costs (-1)-0.171** Constant-2.64*** Wald(chi2) stat (0.000) Arellano-Bond AR(1) (0.0001) Arellano-Bond AR(2) (0.0887) Sargan test: chi (0.2169)

Estimation results: employment by skill Dependant variable: Employment_high Coefficient Employment_high (-1)0.632*** Output0.097*** Capital0.223 *** Labor_costs_own *** Labor_costs_own (-1)0.162 *** Labor_costs_other0.192 ** Constant *** Wald(chi2) stat (0.000) Arellano-Bond AR(1) (0.0000) Arellano-Bond AR(2) (0.2216) Sargan test: chi (0.0740) Dependant variable: Employment _low Coefficient Employment_low (-1)0.665*** Output0.187** Output (-1)0.008 Capital0.097** Labor_costs_own0.200 Labor_costs_own (-1)-0.198*** Constant-3.878*** Wald(chi2) stat (0.000) Arellano-Bond AR(1) (0.0000) Arellano-Bond AR(2) (0.1207) Sargan test: chi (0.0683)

Estimation results: wage equation Adjustment of wages is finished in about 9 months In the long run, 1% drop in SSC lead to 1.5% rise in average wage Average wage would rise by 0.4% due to 1% rise in minimum wage 1% rise in the number of employees working at minimum wage level leads to a 0.23 % drop in average wage Dependant variable: Wage Coefficient Wage (-1)0.427*** %employ. min.wage-0.135* SSC rate-0.877*** Minimum wage0.227*** Capital/labor0.053 Constant3.205*** Wald(chi2) stat (0.000) Arellano-Bond AR(1) (0.000) Arellano-Bond AR(2) (0.874) Sargan test: chi (0.796)

Estimation results: wage equation by skill Dependant variable: Wage_high Coefficient Wage (-1)0.373*** %employ. min.wage-0.507*** SSC rate-1.07** Minimum wage0.269*** Capital/labor0.022 Constant4.111*** Wald(chi2) stat (0.0000) Arellano-Bond AR(1) (0.000) Arellano-Bond AR(2) (0.7525) Sargan test: chi (0.354) Dependant variable: Wage_low Coefficient Wage (-1)0.372*** %employ. min.wage-0.149* SSC rate-0.831** Minimum wage0.269*** Capital/labor0.027 Constant3.672*** Wald(chi2) stat (0.0000) Arellano-Bond AR(1) (0.000) Arellano-Bond AR(2) (0.7170) Sargan test: chi (0.779)

Conclusion Tax cuts can boost employment but not to a great extent Estimation results indicate more than full shifting to wages in case of high-skilled workers Pass through effect is lower for low-wage earners. Reduction in social security contributions from current 17.9% to a 7.9% may reduce labour costs of labour costs of blue collar workers by 1.4 % and increase their employment in the long run by 0.83%. Results provide support for the argument that the employment effects of payroll tax cuts would be more effective in the case of selective tax reductions (only to low-wage earners) instead of applying the general tax cuts