Tuesday, November 29, 2011

Are payroll tax cuts efficient?

While there is ample debate in various countries whether payroll taxes should be reduced or increased, there is little agreement. One side focuses on government revenue generation while the other is worried about the impact of such changes on economic activity. It looks like agreement is unlikely, as this is about different objectives. But maybe there could be.

Ossi Korkeamäki looks at a natural experiment in Finland, where the payroll tax was reduced by 3-6 percentage points in some provinces. As it is levied at the firm level, he studies the impact on firm activity, and finds nothing of statistical significance. If you are willing to look beyond statistical hairsplitting, most of the tax reduction went into profits, a little into wage and nothing into employment. But this is only looking at the firm level, there may be some aggregate effects, like those profits are getting consumed, right? Well, given that those receiving those profits are either pension funds or rich people, which both have lower marginal propensities to consume than the typical wage earner, that is not going to help economic activity either. So, in the end, it just looks like the government lost some revenue in this experiment, and the likely decrease in government purchases cancelled out any small output effect there may have been.


Kansan said...

But Republicans are fine with increasing the payroll tax, which would cut into firm profits. Why would they be willing to do that?

The Unknown Economist said...

Interesting post, first research I've seen on payroll tax cut effectiveness. Your conclusion seems right, though, as most US workers don't even know they've received a tax cut!