Who bears labour taxes and social contributions? A meta-analysis approach

Public economics literature highlights two alternative definitions of the nature of social contributions. On the one hand, they can represent a deferred salary if the link between social contributions and social benefits (pensions and unemployment benefits) is high. This is the case of pension systems with defined contributions. On the other hand, they might be considered a regular payroll tax (such as the labour income tax), if the tax-benefit link is weak, as is the case in many defined-benefit pay-as-you-go pension systems. In this paper we opt for an intermediate position, so social contributions would be treated as a particular labour tax whose revenues are partially affected by social security financing. Therefore, we will concentrate on the labour market dynamics to analyse the incidence of social contributions and, in general, of labour taxes.

The focus will be placed on their economic incidence, i.e., who effectively bears the tax burden and what are its main economic effects (on wages, labour costs and equilibrium employment), rather than on the legal incidence.⁴ This involves analysing the change in behaviour of economic agents after the establishment of the tax. As mentioned above, in the case of social contributions the literature points at two basic shifting processes. Consumers may bear the burden if firms have enough market power to adjust prices to the new tax rates. This is known as forward shifting. Alternatively, employees may bear the burden if the firm offsets the new tax burden with a (net) negative wage variation, leaving labour costs constant, a process known as backward shifting.

Therefore, the dependent variable is the net wage elasticity to taxes. As previously stated, this figure proxies the degree of backward shifting. A \(-\)1.0 coefficient represents the full shifting scenario, where workers bear 100 % of taxes. A null elasticity implies that workers do not bear even part of the tax (null shifting). Intermediate results are more frequent and imply partial shifting processes.⁶

We have assembled a database of 670 estimates of the impact of taxes on net wages from 52 papers, covering most of the OECD countries and some Latin American economies.⁷ This sample is based on a narrative survey (Melguizo 2009), updated using the IDEAS search engine.⁸ We normalised the results to the wage elasticity (based on the labour cost-wage equation equivalence explained in footnote 6), and directly chose this variable as the dependent one.

We restricted our core sample to the preferred estimate in each study for each country or region covered, based on the author’s judgement (when absent, we use the usual statistic tests). This limited the sample to 124 observations from the 52 papers since some of the papers report estimates for different regions (labelled ‘baseline sample’). This option remains open in the meta-analysis literature. Some authors claim that excluding some estimates may bias the studies, weakening the main advantage of meta-analysis over other surveying techniques. However, the inclusion of all the estimates is not cost-free: it may bias the analysis towards those studies that report more results for each country (if their results are similar), or may increase the variability of the results even if the authors manifest their preference for certain estimates (if their results vary).

As mentioned above, the empirical literature highlights the role of economic institutions, particularly the centralisation of wage bargaining and union presence. Centralised economies with strong unions or decentralised wage bargaining with weak unions exhibit lower unemployment rates. In addition, public sector effectiveness may compensate the disincentives from a high taxation, since workers perceive the tax-benefit linkage. Broadly speaking, Nordic and Anglo-Saxon economies have the systems with the best equilibrium, while Continental and Mediterranean economies tend to be placed in an unfavourable intermediate position.

Figure 3 supports this hypothesis suggesting that Nordic economies, characterised by their high centralisation, strong trade unions and effective governments are different. The mode estimate is full shifting (\(-\)1.0 elasticity), while in Anglo-Saxon, Continental and Mediterranean economies workers seem to bear half of the tax burden (\(-\)0.5).⁹ Are these differences statistically significant? Do the a priori results hold when controlling for the complete set of methodological differences? The aim of the meta-analysis performed in the next section is precisely to answer these questions quantitatively.

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Given the relatively recent arrival of the meta-analysis technique in economics, there is no standardised empirical strategy. As previously explained, we restricted the sample to 124 observations (from a complete sample of 670 observations), although we will use the complete dataset to test the robustness of the results. Due to the presence of some extreme values in the sample, robust regression estimation is recommended.¹⁰ We will also include some weighted least squares (WLS) estimates to control the quality of the studies.¹¹

We opt for a sequential approach, in line with Knell and Stix (2003), Evers et al. (2006) and Card et al. (2010). Firstly, we test the significance of geographical and temporal (by decades, from the 1950s to the 2000s) moderators, in the spirit of panel-data fixed effects estimation. This enables a basic specification to be obtained, in which we will include the main economic and methodological moderators as a second step (see Table 1, for the complete set). Instead of including all of these moderators simultaneously, we opt to include them one by one to avoid multicollinearity problems. Afterwards, we incorporate the significant moderators in a combined specification. As a final check, we perform an extreme-bounds analysis to evaluate whether results are influenced by the sequence of estimations.

Baseline specification (‘fixed effects’ moderators)

Firstly, we aim to obtain a baseline specification in the spirit of the fixed-effect panel estimation. Alternative estimations rejected robust geographical effects (we tested for differences in studies covering Latin America, Spain and the US vs. other OECD economies). For this reason, and since some of the economic moderators may be correlated, the basic specification does not include them. No significant temporal fixed effects, defined by the sample period in the data used (identified by the decades covered in case of time series analysis), are found either.

Another issue that should be controlled from the beginning in order to avoid spurious results is the presence of publication bias. It may arise from the tendency to report and/or to publish only the significant results, rejecting the null hypothesis of no effect. In order to reduce its potential influence, we included in our meta-database both published and unpublished papers. More than one third of the sample, 45 estimates, comes either from working papers or mimeos (see Table 2).¹³

Economic moderators

The attention devoted to the economic effects of labour taxation from international organisations, policy makers and academia ranks among the highest in applied macroeconomics, generating an enormous amount of research. However, the main issues affecting our results can be restricted to the following: the role of taxes under different institutional settings, the tax wedge composition, short- vs. long-run results and the role of the social security scheme.

Economic institutions matter. The theoretical and empirical literature shows that the impact of labour taxes on labour costs and unemployment is higher in economies with an intermediate centralisation of the wage bargaining process and a strong trade union presence (see Calmfors and Driffill 1988; Alesina and Perotti 1997; Daveri and Tabellini 2000). In this context, common to Continental and Mediterranean countries, the discipline effect of competition or the internalization of externalities are weak. This contrasts with the behaviour in decentralized Anglo-Saxon economies, and unionized centralized Nordic countries. Our analysis partially confirms this hypothesis. Column II in Table 3 shows that the average elasticity is \(-\)0.59. However, the degree of shifting is much higher in Nordic countries at \(-0.79 (-0.59- 0.20)\). This could be an indicator of the benefits of good governance, since Nordic public sectors are among the most effective (see Sapir 2006). By contrast, no significant differences were found between Anglo-Saxon and Continental-Mediterranean economies.

Throughout this paper we use the terms ‘tax wedge’, ‘labour taxation’ and ‘social security contributions’ in a flexible way, implicitly accepting the tax invariance theorem. However, there are several reasons to justify a differential impact of the fiscal wedge components. Focusing on social contributions, even though they are usually a payroll tax, their tax base and tariff usually differ from those of personal income taxes (not to mention the linkage effect), and consumption taxes (see OECD 1990, 2007). Additionally, the salary wedge includes the price wedge, that is, the gap between producer and consumer prices.

Formally, we define pit as the personal income tax effective rate, essc the employee social security contributions rate, fssc the firm social security contributions rate, ctthe consumption tax rate, pp the domestic output deflator, pp* international prices deflator, \(a\) the share of domestic products in the consumption basket, and \(e\) the exchange rate. The ‘salary wedge’ (wedge between the nominal labour costs and the net real wage) can be defined as \(\left[ {\frac{( {\text{1+ct}})( {\text{1+fssc}})}{( {\text{1-pit}})( {\text{1-essc}})}} \right]\left[ {\frac{\text{ epp*}}{\text{ pp}}} \right]^\mathrm{{1-a}}\). The ‘fiscal wedge’ includes exclusively the tax components of the salary wedge and can be expressed as \(\left[ {\frac{( {\text{1+ct}})( {\text{1+fssc}})}{( {\text{1-pit}})( {\text{1-essc}})}} \right]\). The ‘direct tax wedge’ only focuses on taxes on income as \(\left[ {\frac{( {\text{1+fssc}})}{( {\text{1-pit}})( {\text{1-essc}})}} \right]\) and, finally, the ‘employer social taxes wedge’ can be written as (1+fssc).

Therefore, we tested the impact of alternative fiscal wedge definitions, starting from the general salary wedge (fiscal wedge plus price wedge), down to employer social security contributions. Results confirm that different taxes have different effects on wages. While the elasticity of net wages to labour taxes is \(-\)0.59, the salary and fiscal wedge impact (inclusive of indirect taxes and of price wedge between output and consumption in the first case) is close to 80 % (\(-0.79 = -0.59-0.20\), as shown in column III in Table 3).

Moreover, as highlighted in Hamermesh (1993), the presence of lags in the shifting of social contribution is usually significant (on average, long-run shifting equilibrium takes more than a year) due to the presence of nominal rigidities. Our estimation confirms this point (column IV in Table 3). The short-run elasticity \(-0.43 (-0.74 + 0.31)\) is lower than the long-run counterpart, \(-\)0.74. Therefore, workers bear less than half of the tax burden in the short run (generally represented by results during the year of the tax change).

Finally, a key institutional issue that has to be tested is related to the social security scheme. In particular, the literature highlights a potential role of the ‘linkage effect’, that is, the perception of the link between contributions and social benefits (see Gruber and Krueger 1990; Gruber 1994a; Gruber 1994b; Disney 2004). Social contributions would have no effect on the equilibrium employment rate if agents perceive a full linkage effect, since they become a deferred salary (positively shifting the labour supply curve). This tends to be the case in contributory Bismarckian social security systems, in contrast to redistributive pension systems à la Beveridge. Our empirical analysis obtains the expected sign, since shifting is lower in more redistributive systems, but the effect is not significant (coefficient 0.10, column VIII in Table 6).¹⁴

Other moderators

A second set of moderators tries to reflect methodological differences, from both the data (economy-wide or private sector, and its frequency) and the estimation techniques (cross-section, time series or panel, and selected estimator). Our analysis suggests that data coverage is relevant. Studies that refer to the entire economy, and not just the market economy, tend to show higher negative elasticities, \(-0.73 (-0.52-0.21\); column IX in Table 6). We are not convinced of its implications, since wage bargaining in the public sector is not competitive. Finally, more than half of the papers include labour costs, rather than the net wage, as the dependent variable. Those studies tend to obtain a higher negative elasticity (\(-0.80 = -0.43-0.37\); column X in Table 6), although no economic implication seems straightforward either.

Combined results

To conclude, we incorporated all the individually significant moderators into the specification (column V in Table 3). Every coefficient keeps its sign, but only the temporal focus and the dependent variable definition remain significant. Finally, column VI (Table 3) presents our baseline specification, focused on the moderators that have a more solid economic foundation. In this case, the net wage elasticity is \(-\)0.70, so workers bear 70 % of the tax burden via lower wages (or lower wage increases), somewhat lower than the starting estimate surveyed in Fuchs et al. (1998). In the Nordic economies the degree of shifting is higher, close to 90 % (\(-0.88 = -0.70-0.18\)), so nearly all the tax changes are offset by negative wage variations. Finally, we confirm that shifting takes time, and in the short run workers bear less than 40 % of the tax burden (\(-0.39 = -0.70 + 0.31\)).¹⁵

In order to further check the robustness of the results, we first tested whether the main results hold for the whole sample (670 elasticities from the 52 papers). Results, reported in columns XI to XV in Table 6, are in line with the ones reported for the core sample. These additional tests confirm that shifting is higher in Nordic economies, in studies that include indirect taxes in the tax wedge and in the long run. However, only the latter is significant. The publication bias hypothesis seems also present, with the aforementioned caveats on its downsizing effects to the sample. Taking all these considerations on board, our baseline specification for the complete sample is reported in column XIV. The net wage elasticity is \(-\)0.85, so workers bear 85 % of the tax burden. In the short term the backward shifting process is lower as well (\(-0.51 = -0.85 + 0.34\)).

Additionally, we performed a quality control study of the literature other than the publication format (books, journals, working papers and mimeos). Specifically, we used Google Scholar to weight each estimate for the number of citations.¹⁶ The weighted least square estimation of the baseline sample is reported in columns XVI to XVIII in Table 6. In comparison to our baseline specification, estimates confirm that taxation shifting is significantly lower in the short run. However, the shifting degree seems higher, and does not depend on the economic model.

Finally, we tested how sensitive results are depending on the specification selection procedure. In particular, we calculated the confidence intervals of the impact of taxes on wages, based on the ‘extreme-bounds analysis’.¹⁷ The lowest bound is obtained including fixed effects and controlling for the study coverage (ECO) and the publication format (BOOK, WP + MIM): \(-\)0.10 (\(-\)0.45 minus two standard errors). The highest one stems from a specification with the social security model (BEVSS) and the time horizon (DEPVAR): \(-\)1.09 (\(-\)0.77 plus two standard errors). Therefore, this test robustly rejects the no-shifting hypothesis.