1. Payroll taxes Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

2. What are we talking about? Payroll taxes = income taxes & social security contributions Payroll taxes drive a wedge between labor costs and net wage Social security – deferred consumption (public pensions) Incidence of taxation is relevant Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

3. Overlaps with other institutions Family policies Unemployment benefits Unions Active labor market policies Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

4. Outline 1.Measures and cross-country comparisons 2.Theory 3.Empirical evidence 4.Policy issues 5.Why do payroll taxes exist? 6.Review questions Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

5. Measures Average tax rate Marginal tax rate Marginal effective tax rate Progressive tax system Social security: employer – employees Tax systems are complex – impossible to summarize by one particular number Include VAT? Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Cross-country comparisons

6. Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

7. Cross-country comparison Average production worker wage (APW): annual gross wage earnings of adult, full-time manual workers in manufacturing sector Average payroll tax rate: 17.2 (Korea) – 55.4 (Belgium) Marginal tax rate: 22.8 (Mexico) – 76.9 (Hungary) Most countries (except Sweden and Turkey): marginal tax rates substantially higher than average tax rates – progressive tax systems Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Cross-country comparisons

8. Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

9. Cross-country comparison II Effects tax-benefit system on net income of various types of workers: Household net incomes of working lone parents higher than net incomes of working singles Sometimes for one-earner couple with two children net income higher than gross income Single worker net income during initial phase of unemployment: 25% (Australia) – 66% (Luxembourg) Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Cross-country comparisons

10. Cross-country comparison III Changes in labor market position: Single earner from inactivity to 67% of APW – marginal tax rate sometimes more than 100% One spouse 67% APW other moves from inactivity to 33% APW; marginal effective tax rate: 7% (Korea) to 89% (Denmark) Polarization work-rich and work-poor families: –Neither is working – big disincentives –One is working – substantially smaller incentives Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Cross-country comparisons

11. Theory – effect on functioning labor market 1.Presence of taxes – not necessarily 2.Structure of taxes – yes Labor supply – extensive & intensive margin Labor demand – increase in costs Wedge Competitive markets: tax paid by worker/employer – slopes demand & supply curves Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Theory

12. Perfect labour market L w LdLd LsLs A w0w0 wsws wdwd Tax C B Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Theory L1L1 L0L0

13. Tax cut L w Ld1Ld1 LsLs A w0w0 w1w1 Tax Reduction B Ld2Ld2 L0L0 L1L1

14. When Labour Supply is rigid..

15. When Labour Supply is more elastic than Demand …

16. Theory – non competitive labor market Pissarides (1998) 3 possibilities: 1.Wage bargaining between unions and firms 2.Wage bargaining between individual firms and unemployed workers (search models) 3.Efficiency wages Role of tax structure (progressive vs. proportional) Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Theory

17. Collective Bargaining Labor supply curve  wage-setting equation – slope increases. Workers use their market power to take most of a decrease in taxes Unemployment as disciplining device for encompassing (co-ordinated) unions – centralized bargaining. When taxes increase, wage claims are reduced, flatter wage setting equation More so when taxes are less progressive: more effects on employment. Only with proportional taxes (and UBs taxed) no effects on employment

18. Search models Transaction costs and rents related to search frictions. Some unemployment is efficient. If benefits are fixed and taxed like wages, then no effects on employment. Only on wages. Otherwise effects like a change in unemployment benefits

19. Efficiency wages Higher wages/unemployment are required to discourage shirking: disciplinary device In a standard Shapiro-Stiglitz setting, once satisfied the No-Shirking condition, the supply is rigid: only labour demand shifts in this case. Taxes change wages but not employment Progressiveness of taxation is also not relevant in this case. Only the size of the wedge matters as in the competitive model

20. Empirical evidence Labor supply of men not much affected by changes in tax rates Labor supply of women increases if net wage increases 4 groups of workers where high taxes may affect behavior: in work with high incomes, in work with low incomes & eligible for benefits, those nearing retirement and those considering entrance into the labor force Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Empirical evidence

21. Box 4.1 The incidence of payroll taxation Gruber (1997) Change of financing social insurance in Chile in 1981: from payroll tax for manufacturing firms to general revenues. Payroll taxes drop from 29% to 5.5% Reduced payroll taxes fully passed on to wages % effectWagesEmployment Blue collar-0.90.2 White collar-1.4-0.2 Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Empirical evidence

22. Policy issue 1: Negative income taxes or in- work benefits? Means-tested welfare system: welfare is reduced one for one when individual starts making money; alternatives 1.NIT: initial level benefits lower, withdrawn with a percentage 2.IWB: individuals only receive benefits if they work – phase-in & phase-out range Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Policy issues

23. Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Policy issues

24. Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Policy issues

25. Policy issue 1: Negative income taxes or in- work benefits? IWB: stimulate labor supply at extensive margin – reduce incentives at intensive margin NIT: adverse effects on labor supply along extensive margin Optimal system depends behavioral response of individuals: –Mostly along intensive margin: NIT –Mostly along extensive margin: IWB Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Policy issues

26. Box 4.2 In-work benefits in action Card and Hyslop (2005) Canadian Self Sufficiency Project - % on income assistance No permanent effects YearsControlProgramEffect 0.590.883.17.7 183.772.411.3 273.063.39.7 365.458.86.6 456.753.53.2 550.648.42.2 5.7545.0 0.0 Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Policy issues

27. Policy issue 2: Tax credits or wage subsidies? Provided to firms. Influence hiring decisions Wage subsidy = direct transfer Both: hire specific categories of workers Tax credits need no separate administration Dead-weight losses Subsidizing marginal employment = difficult to use in practice Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Policy issues

28. Why do payroll taxes exist? Funding government expenditures Social security contribution parts directly related to the functioning of labor markets Contribution to public pension programs: tax or savings? Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press. Policy issues

29. Review questions 1.How do in-work benefits affect incentives of unemployed workers? 2.Why does the impact of taxes depend on the nature of the labor market? 3.What is the trade-off between wage subsidies and tax credits? Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.