Taxation of labour: the effect of labour taxes and costs on employment in Macedonia

Abstract

The objective of this article is to investigate the effect of tax and social contributions reforms on employment in Macedonia, through estimating a labour demand function over the period 1998:Q1–2010:Q3. The results are used to establish a foundation for an evidence-based policy for increasing employment in a country with high unemployment, while recognising the reality of budget constraints. The article disaggregates the total tax wedge into an income tax wedge and a social contributions wedge, in order to test the argument that the main burden on labour in transition economies stems from social contributions and not from income taxation, mainly due to the dominance of unskilled jobs in those countries. We also impose a control for the introduction of the gross wage concept in 2009, which is said to have had the effect of reducing the informal economy. We find that the reduction of social contributions has a significant effect on employment in Macedonia, ranging from 0.9 to 3.1 percentage points. The effect of the income tax wedge is found to be insignificant. Moreover, the estimates relating to the gross wage concept and the associated measures provide some evidence for the view that the reform generated a transfer from the informal economy into formal employment, thus most probably shrinking the grey economy in the country.

Acknowledgements

Author thanks: participants at the international workshop “Crises, Institutions and Labour Market Performance: Comparing Evidence and Policies” (Peruga, Italy, November, 2011) and the European Association for Comparative Economic Studies, especially Milica Uvalic, Tomasz Mickiewicz and Marcello Signorelli; Marjan Petreski; and the two anonymous referees for the very useful comments and suggestions on earlier drafts of the paper. All remaining errors are of the author only.

Notes

1. The State Statistical Office (2010) estimated informal employment in Macedonia at 26.4% of the total employment in 2009. The same publication presents data for 2007 and 2008, showing slightly declining informal employment (from 28.1% in 2008). However, there is no consistent longer time series for informal employment. For a more detailed discussion on informal employment in Macedonia, and its incidence among different categories of wage earners, see Angel-Urdinola and Macias (2008).

2. The Ministry of Finance projects that the budget deficit will remain at 2.5% of GDP until 2013 and then decline to 2.2% in 2014.