Céline AzémarUniversity of Glasgow

(Co-written with Rodolphe Desbordes, University of Strathclyde)

IFS/ETPF Conference, London 27 April 2009The Impact and Design of Business Taxation in a Globalised World

Who Ultimately Bears Non-Profit Taxes Paid by Business?

1. Introduction

Introduction The concern:

Growing concern of decisions makers about the effects of labour taxes on the economic activity.

Labour costs have been frequently blamed for the high unemployment rate in OECD countries.

From a theoretical perspective, the extent to which an increase in labour taxes generates higher unemployment depends on who ultimately bears the additional tax burden, i.e. the employers or the workers.

Ambiguous empirical findings: On the one hand: Labour costs explain a substantial share of the rise in

unemployment → this suggests that the costs of labour taxes is not entirely passed on to workers (Daveri and Tabellini, 2000; Nickell, Nunziata and Ochel, 2005).

On the other hand: various studies argue for an absence of real wage resistance, at least in the long run (Layard, Nickell and Jackman, 1991; Gruber, 1997).

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

Introduction

Aim of the paper:

To shed light on the impact of rising employer’s labour taxes on labour costs in OECD countries.

Specifically, we focus on the effect of an increase in employer’s

non-wage compensation costs which correspond to “employer social insurance expenditures and other labour taxes”:

By distinguishing between short-run and long-run effects; By considering the influence of wage bargaining coordination.

Analysis covers 14 OECD countries over the period 1980-2004.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

2. Previous work

Previous WorkTheory:

In standard payroll tax incidence models:

An increase in employer costs decreases the demand for labour, leading to a decrease in wages and employment.

The shift of employer costs to wages mitigates the decline of employment.

The magnitude of this shift depends on the elasticities of labour supply and demand.

Theory of mandated benefits:

If employees value the benefits that they are receiving from social security expenditures → a higher share of taxes paid by employers will be shifted to the workers (Summers, 1989).

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

Previous Work

Theory:

The role played by bargaining coordination

Workers’ valuation of the benefits they are untitled to, and thus the ability of firms to shift labour costs to wages, may differ across countries.

→ Depend on the union wage bargaining structure of the country (Summers, Gruber, Vergara, 1993; Alesina and Perotti, 1997).

Under highly centralised/coordinated bargaining → unions are more likely to internalise the relationship between contributions to be paid and benefits to be received.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

Previous Work

Empirical evidence:

Incidence of particular mandates: Gruber and Krueger (1991): 85% of the increase in worker's

compensation insurance for workplace injuries is shifted to employees.

Gruber (1994): 100% of the increase in mandated maternity benefits is shifted on wages of the targeted group.

Incidence of employer’s labour taxes: Gruber (1997): ↓ of labour taxes in Chile → A full-shifting of

payroll taxation to blue and white collars in the form of higher wages.

Ooche et al. (2003): 6 OECD countries → ↑ of labour taxes → more than 50% is shifted to the employees.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

3. Empirical analysisData and model

DataDependent variable: Compensation costs

“Compensation" is the real average hourly compensation costs computed by the Bureau of Labor Statistics (BLS).

This measure is prepared specifically for international comparisons of employers labour costs in the manufacturing sector.

It includes: (i) hourly direct pay, (ii) employer social insurance expenditures for legally required insurance programs, contractual and private benefit plans, and other taxes on payrolls or employment.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

DataVariable of interest: Employer’s non-wage compensation

costs (NWCC) rate

Corresponds to hourly (i) social insurance expenditures and, (ii) other labour taxes paid by the employer, as a share of the gross wage paid to the employee (in manufacturing).

(i) Social insurance expenditures for legally required insurance programs, contractual and private benefit plans include: • retirement and disability pensions,• health insurance, • income guarantee insurance and sick leave, • life and accident insurance,• occupational injury and illness compensation, • unemployment insurance,• family allowances, • other social insurance expenditures.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

OECD Employer’s Non-Wage Compensation Costs (NWCC) Rate 1980-2004

Source: Bureau of Labor Statistics (2006)

EstimationBaseline equation:

Interpretation: If the cost of social insurance expenditures and other labour taxes is

not entirely passed on to workers in the form of lower wages, an increase of 1% of these taxes will increase compensation costs: β6>0.

If there is a full shifting to wages, the compensation costs paid by employers will not rise and the coefficient β6 will equal zero.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

4. Empirical analysisResults

Who bears the burden of:

Employer’s Non-Wage Compensation Costs?

Result 1: Basic model

Control variables

Higher labour productivity, a fall in unemployment and a positive price wedge, are associated with higher labour compensation.

Trade openness leads to lower labour compensation → increased competition from developing countries in the production of manufacturing goods.

Variable of interest: NWCC rate

NWCC rate has a positive coefficient, statistically significant at the 5% level.

At the sample mean (NWCC rate = 28%), a 1% point increase in the NWCC rate would lead to a rise in labour costs of about 0.23% and a fall in gross wages of about 0.55%.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

Who bears the burden of:

Employer’s Non-Wage Compensation Costs?

Result 2: Robustness of the effect of the NWCC rate

Control for a potential endogeneity bias

The method employed (OLS) would produce biased and inconsistent estimators if the tax variable is endogeneous.

This can be handled through an instrumental variable approach (2SLS).

Instruments: the first lag and the first lag squared of the labour tax rate.

Result

The instruments are valid and the hypothesis of endogeneity rejected.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

Who bears the burden of:

Employer’s Non-Wage Compensation Costs?

Result 3: The role played by trade unions

Intuition

Employers' ability to shift costs may depend on the structure of the bargaining process, i.e. on the extent to which wage bargaining is coordinated (Summers et al.,1993; and Alesina and Perotti,1997).

Trade unions operate in very different ways across OECD countries → the impact of NWCC rate on labour cost can thus diverge across countries.

Index of bargaining coordination created by OECD (2004): ranging from 1 to 5, the index is increasing in the degree of coordination in the wage bargaining process.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

Bargaining Coordination

Source: OECD (2004)

Who bears the burden of:

Employer’s Non-Wage Compensation Costs?

Test of the influence of the degree of coordination

The bargaining coordination index is interacted with the variable NWCC.

The impact of a rise of the NWCC rate on labour costs decreases with the degree of bargaining coordination.

Under high bargaining coordination (Norway, Denmark or Germany): absence of a significant effect of the NWCC rate on labour costs. At the sample mean, wages would fall by at least 0.65% following a 1% point rise in the NWCC rate.

In countries with low degree of bargaining coordination (Canada, U.S., U.K.): gross wages would decrease by 0.37%.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

Impact of the NWCC rate on labour costs depending on the degree of coordination

Who bears the burden of:

Employer’s Non-Wage Compensation Costs?

Result 4: Dynamics

Intuition

We distinguish between the short-run and the long-run effects of an increase in the NWCC (real wage resistance may vanish with time).

Result

The long-run effect does not appear to be different from the short-run effect.

Hence, a change in NWCC rate only have an immediate effect on labour compensation, but with permanent consequences.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results

5. Concluding remarks

Concluding remarks

Analysis of the short-run and long-run effects of a change in employer’s social insurance expenditures and other labour taxes (NWCC) on real manufacturing labour costs in 14 OECD countries over the 1980-2004 period.

We find that a 1% point rise in the NWCC rate leads to a permanent rise in labour costs of 0.23% and a fall of gross wages of 0.55%.

Countries’ attractiveness: the size of the tax shifting suggests that the location decisions of multinational companies are unlikely to be too much affected by an increase in such taxes.

Unemployment: Corroborate the findings that a rising labour tax leads to higher unemployment.

The distribution of this effect between employers and employees is influenced by the degree of coordination of the bargaining process.

1. Introduction 3. Data and Model 5. Concluding remarks

2. Previous Work 4. Empirical Results