Saturday, September 22, 2012

Europe's payroll taxes

The Wall Street Journal made this nice graph on Saturday.

Forget "who bears," it's the totals here that are mind-boggling. In most countries, if you add up the "employer" and "employee" contributions, you get between 30 and 40%. So, if a worker produces 100 euros worth of output, 30-40 euros immediately go to the government. And there is an additional 20%+  VAT when the worker goes to buy something. So, right out of the gate, we have a 50-60% wedge between working and the fruits of labor. Income taxes, corporate taxes and property, excise, and other taxes are all on top of that! It's a wonder anyone in Europe bothers to work at all.

(I haven't looked in to the numbers, but I presume the European numbers include financing of their health systems, and the US number does not. Don't feel so cheeky.) 

The story was about a proposal to shift "employer contribution" to "employee contribution" in Portugal, as "the title" who bears the burden" suggests.

Economists will quickly tell you that who pays the tax doesn't matter. Gas stations pay the gas tax, but everyone can see that it is all passed on as higher gas prices; we're not "socking it to the rich oil companies" with gas taxes.

But if wages are "sticky," especially if fixed by union contract or law forbidding cuts, then this argument fails, and the Portugese transfer is an interesting way to lower wages without devaluing the currency, changing the overall tax wedge, or repealing laws forbidding wage cuts. 

Apparently the protesters in the streets figured that one out. If they figure out that nominal wage increases offset the whole thing, then we're back to the standard theorem.


Casey Mulligan and one commenter noticed that I oversimplified.
It's not huge but not rounding error either: you cannot just add the employer and employee rates in order to quantify the combined distortion, unless wages are held fixed, because the employer contribution is omitted from the payroll tax base. The formula typically used by tax economists is:


Eg a 100% employer tax is very different, and much less damaging, than a 100 percent employee tax. Your error is largest when the employer rate is far from zero, which it is in Europe.
Good point, and in retrospect it's better to use the right formula than simplify too much, even here. However, for everyone else, keep in mind that this is not a serious attempt to measure the overall total marginal disincentive in tax and transfer systems. The point is that this rather large social insurance wedge is at the beginning; we add income taxes, means-tested transfers, phaseouts, wealth taxes, etc to this rather large base. We keep talking about income taxes as if they existed in a vacum.

On the quesiton whether it's a tax because you get benefits: What counts is the margin. A forced savings plan has very little disincentive. If you have to save 10% of income, you get the results eventually. The wedge is only how much you'd really rather have the income today. US social security has a bit of you get more if you pay more, but not that much. And my impression is that european social insurance systems give much less marginal benefit for marginal contributions. (Commenters, I'm curious to hear facts on that)