Statutory and economic incidence of labour taxes

Abstract

A revenue-neutral substitution of a payroll tax for an income tax reduces unemployment in a general efficiency wage model in which firms are characterized by a constant returns to scale technology. This employment variation is the reverse of the change which arises in collective wage bargaining models. Hence, empirical work on the determinants of unemployment should always allow for the possibility of differential effects of taxes levied on workers and firms. The positive employment effect in the efficiency wage economy occurs since the income tax, in contrast to the payroll tax, is characterized by a positive level of tax exemption. Therefore, a revenueneutral substitution requires a less pronounced increase in the payroll tax than it allows for a fall in the income tax. Profits rise and an employment expansion is needed to reduce the workers' effort and, subsequently, the firms' profits to their equilibrium level.