Abstract
I relate hours worked with taxes on consumption and labor for Portugal, France, Spain, United Kingdom and United States. From 1986 to 2001, hours per worker in Portugal decreased from 35.1 to 32.6. With the parameters for Portugal, the model predicts hours worked in 2001 with an error of only 12 min from the actual hours. Across countries, most predictions differ from the data by 1 h or less. The model is not sensible to special assumptions on the parameters. I calculate the long run effects of taxes on consumption, hours, capital and welfare for Portugal. I extend the model to discuss implications for Social Security. I discuss the steady state and the transition from a pay-as-you-go to a fully funded system.
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Notes
It is approximately the number of productive hours available per week.
The ratio of consumption to production, c t /y t , depends on the expectations about the future. Although the ratio c t /y t is an equilibrium variable, we only need its value, given by the data, to obtain a prediction for the number of hours worked.
In the calibration, α is obtained such that the sum of square differences between the actual values and the predictions for the period 1986–1988 is minimized.
The sources of data are the OECD publications National Accounts, Detailed Tables: vol II and Revenue Statistics of OECD Member Countries. I used the OECD online dataset SourceOECD. The codes in the Revenue Statistics for each variable are as follows. Indirect taxation IT is given by the sum of items 5110 and 5121. Social security contributions are given by item 2000, it considers contributions from employers and employees. Direct taxes of individuals, by item 1100.
The difference between the calculations with or without the government sector are about five percentage points for this period.
Gollin (2002) obtains further evidence for this number and for the stability of the labor share. The labor shares are approximately constant, in the range of 0.65 and 0.80, once the labor income of the self-employed is treated carefully. The conclusions of the present analysis do not change if we consider other values in this range.
This number is the increase in tax revenues if all workers had an increase in their incomes of 1%.
In the model, labor supply from consumers and labor demand from firms act together to imply the equilibrium quantity of labor. Other models include additional features of the labor market that can also influence the behavior of hours worked. Here, I study how much the model in question is able to account for the pattern of hours worked.
For the labor force, I use “average actual annual hours worked per person in employment” from the OECD. I divide the annual hours by 52 to write the values in weekly hours.
Labor income taxes are available since 1989 for Portugal. I maintained the labor income tax rate during 1986–1988 equal to its value in 1989 to calculate τ from 1986 to 1988.
Prescott (2004) focuses on the periods 1970–1974 and 1993–1996.
Prescott (2004) adds 2/3 of non-military government expenses to private consumption to obtain his measure of consumption.
Davis and Henrekson (2005) provide empirical evidence on the effects of taxes on the labor supply and on the underground economy.
For Portugal and Spain, the two series used for the predictions are below the series calculated by this method by around one percentage point.
This yields β = 0.9811 and δ = 0.046, for the tax rates for Portugal, and implies k/y = 3.5, in accordance to the data by Klenow and Rodriguez-Clare (1997). For the Social Security exercise below, β = 0.9844. These and the other parameters have a small effect on the welfare compensations.
The welfare compensation takes into account the increase in G. If this is not taken into account, then the welfare gain decreases to 5.3%. If only private consumption is considered with α = 1.39, then v = 5.8%.
Social Security data from Rodrigues (2006), Table 2.1, p. 52.
The following simulations study some options for Portugal and instigate further analyses. It is beyond the scope of the paper to offer a detailed analysis of a reform of the Social Security system. For more complex models of Social Security see, for example, Kotlikoff et al. (1999) and Imrohoroglu et al. (1999), for models with overlapping generations closer in spirit to the present analysis; and volume 2 of the Review of Economic Dynamics, dedicated entirely to Social Security. Prescott (2004) discusses a Social Security reform for the United States. I make different assumptions on the parameters and on the details of the Social Security system. I also consider different options for the transition.
I use the same number of periods for active and retired workers as Prescott to facilitate comparison. These numbers are similar to the numbers for Portugal. According to the Anuário Estatístico do INE 2005, p. 123, the average retirement age for Portugal is 62 years.
Auerbach and Kotlikoff (1987) do not have this kind of transfers, but they allow τ to change to satisfy the government budget constraint. Introducing transfers allows us to maintain taxes fixed and study different implications.
These modifications of the original problem imply reasonable equilibrium values and individual dynamics. For a more complex model for the lifetime behavior of consumption and savings see, for example, Rios-Rull (1996). The model of Rios-Rull, on the other hand, does not have social security nor taxes, and completely abstracts from government.
As Kotlikoff et al. (1999) state, having this mandated private account for retirement is equivalent to setting the Social Security tax to zero since agents are not liquidity constraint in this economy.
This is different from Kotlikoff et al. (1999), which keep G fixed. I have also calculated the welfare effects with G fixed (such that G/Y = 0.19 for the first policy) and the difference is small. I have also calculated for G = 0 and the welfare effects are also similar.
The reference wage in Portugal is the average of the best 10 of the last 15 years of wages reported (Rodrigues 2006, p. 64). It was calculated in the same way in the present paper. The replacement ratio in Portugal ranges between 30 to 80% for about 53% of the beneficiaries.
Even with the simplifications in this paper, it is interesting that the model is able to generate reasonable numbers for this ratio. Old-age pensions as a fraction of GDP are equal to 4.95% for Portugal in 2003 and the analogous figure for total Social Security expenditures is 12.5% (Rodrigues 2006, p. 63).
Total tax revenues \(\left( \tau _{h}+\tau _{SS}\right) H_{t}\) decrease.
The welfare gains are smaller than the ones shown in Table 4 because transfers are smaller in this alternative and because long run government consumption is higher if we keep G/Y = 0.19.
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This is a revised and extended version of the paper with the same title prepared for the III Conference “Desenvolvimento Económico Português no Espaço Europeu”, organized by the Banco de Portugal and that took place on February 2006. The original version was intended for an academic and non-academic audience. It may be found at the conference proceedings. I thank Antonio Pinto Barbosa, Pedro Pita Barros, Paulo Brito (the editor), Susana Peralta and two anonymous referees for useful comments that greatly improved the paper.
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Silva, A.C. Taxes and labor supply: Portugal, Europe, and the United States. Port Econ J 7, 101–124 (2008). https://doi.org/10.1007/s10258-008-0029-1
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DOI: https://doi.org/10.1007/s10258-008-0029-1