EMPLOYMENT EFFECTS OF TAX CUTS: THE CASE OF SERBIA Jelena Žarković Rakić Faculty of Economics Universy of Belgrade
Motivation Since 2000 Serbia experienced relatively high GDP growth rates At the same time, employment rates rather low, even negative Which factors prevent job creation in the economy?
Motivation Focus on labor taxes (labor tax wedge) Policy recommendation of the OECD Jobs Study (1994): "Reduce non-wage labour costs, especially in Europe, by reducing taxes on labour..." "Reduce direct taxes (social secury and income taxes) on those wh low earnings Nickell and Bell (1996), Nickell and Layard (1999) Daveri and Tabellini (2000) World Bank (2005)
Tax-employment link in Serbia Arandarenko and Stanic (2006): tax wedge in Serbia accounts for about 40% of total labor costs on average. Comparatively, tax wedge is average at higher wage levels, but high for low wage earners
Tax-employment link in Serbia Arandarenko and Vukojevic (2008): found rather low (short-run) elasticy of labor costs wh respect tto labor demand d negative, but not significant impact of labor tax wedge on employment level
Contribution Find evidence for tax-employment link at the micro level in Serbia Show that policy aimed at reducing labor taxes for workers of certain skill categories would be more favorable for employment than applying ppy across-the- board-tax cuts To justify selective labor tax reductions across skill types, focus on tax-shifting phenomena
Tax shifting Tax shifting ( pass-through ) exists when legal tax incidence differs from actual economic burden of the tax The larger the passthrough, the less impact that a reduction in taxes will have on labor cost. As a result, any gain in employment will also be less.
Tax shifting Gruber (1997): large reduction in SSC was fully shifted onto higher wages wh no posive effects on employment Korkeamaki and Uusalo (2006): increase in wages offset roughly half of the impact of the SSC cut on the labour costs Kugler and Kugler (2008): 1/5 of SSC increase was shifted onto lower wages. Less shifting for low-skilled workers Taymaz (2007): also founds lower degree of shifting for low-skilled earners
Empirical model Dynamic employment equation is in the panel data form: N = α 1N i, t 1 + α 2 w + α 3k + α 4q + v wh v = μ + λ + u i=1,,n; t=1,,tt i t where N is the number of employees in the establishment i and year t, w is the real product wage (labor costs), k is the capal stock and q is the output
Empirical model The same model is estimated separately for highskill and low-skilled workers: N q + H H H H L L = γ1ni, t 1 + γ 2 w + γ 2 w + γ 3k + γ 4 v L L L L H H N = δ1 Ni, t 1 + δ 2 w + δ 2 w + δ3 k + δ 4 q + v
Empirical model How wages respond to changes in taxation - wage equation: w kl + mw = β1wi, t 1 + β2τ + β3 n + β4mwt + β5 τ Coefficient of the variable stands for the ratio between social secury contributions and gross wage (SSC rate); measures the level of tax-shifting mw n number of minimum wage earners in the labor force, mw minimum wage and kl capal-labor ratio. v
Data Two datasets: RAD survey (Statistical Office of Serbia) and Solvency register (National Bank of Serbia) The sample consists of a panel of manufacturing firms observed for the period 2002-2007 Firms classified into several industrial groupings: capal goods and consumer durables, consumer goods and intermediate t products
Estimation method In case of dynamic models, standard panel estimation techniques would produce biased and inconsistent estimates More appropriate methods developed; most of them based on generalized method of moments (GMM) using different sets of instruments Blundell and Bond (1998) proposed the most efficient set of instruments t whin the framework of the system GMM estimator
Estimation results
Estimation results Coefficient of lagged labor demand variable measures how rapidly labor demand adjust to a shock in product demand or factor prices It takes about 1.9 years to move halfway to the eventual equilibrium employment level low flexibily of labor market Long run wage elasticy for total employment ranges from -0.5 to -0.76 076 The long run own wage elasticy for high-skilled workers whin the range of 1.09-1.98 and for low-skilled employees whin the range of 0.6-0.9 Long run total wage elasticies (0.05-0.27) are lower than long run own wage elasticies
Estimation results
Estimation results Adjustment of wages is finished in about 9 months SSC rate variable has a negative and significant coefficient in all industrial groupings g The pass-through effect is the smallest for establishments that produce intermediate products More than full tax shifting to wages is found in capal and consumer goods industries The level of pass-through is lower for low-skilled employees than for high-skilled ones in all industrial groupings Cut in SSC from current 17.9% to a 7.9% may reduce labour costs of blue collar workers by 1.4 % and increase their employment by 0.83%
Conclusion Reducing labor tax wedge through a cut in SSC advocated in policy and academia circles in Serbia Results show that SSC cuts can increase employment, but not to a great extent Results indicate more than full shifting to wages in case of fhigh-skilled h workers Support for the argument that the employment effects of SSC cuts would be more effective in the case of selective tax reductions (only to low-wage earners) instead of applying the general tax cuts