Taxation: What's Best for Employment?

Workers carry approximately two-thirds of the tax burden

17/10/2013

José Manuel González-Páramo

In their article, "Who Bears Labor Taxes and Social Contributions?" IESE Professor José M. Gonzalez-Páramo and Ángel Melguizo, of Inter-American Development Bank, examine the impact of taxation on wages and employment.

Labor taxes, such as social security contributions, can be borne three ways: by employers, ultimately reducing company profits; by employees, reducing their net wages; or by consumers, through price increases.

Overall, employees bear the bulk of the tax burden via lower wages or lower wage increases. On average, a 1 percent increase in taxation lowers wages by 0.66 percent, which means workers carry approximately two-thirds of the tax burden.

In many countries, the link between taxes and lower wages has exhibited a negative effect on labor supply and acted as a disincentive for employment.

Since the '90s, many European governments have been following the path of the United States in cutting social security payroll taxes to stimulate employment.

However, there is a considerable difference between countries. While the two-thirds tax burden applies to workers in most European and Anglo-Saxon economies, this burden rises to nearly 90 percent in Nordic economies. What explains these differences?

Read full article on the IESE Insight website.