Earnings Determination and Taxes: Evidence From a Cohort-Based Payroll Tax Reform in Greece

Abstract

This article analyzes the response of earnings to payroll tax rates using a cohort-based reform in Greece. Individuals who started working on or after 1993 face permanently a much higher earnings cap for payroll taxes, creating a large and permanent discontinuity in marginal payroll tax rates by date of entry in the labor force for upper earnings workers. Using full-population administrative social security data and a regression discontinuity design, we estimate the long-term labor supply effects and incidence of payroll tax rates on earnings. Standard theory predicts that in the long run, new regime workers should bear the entire burden of the payroll tax increase (relative to old regime workers). In contrast, we find that employers compensate new regime workers for the extra employer payroll taxes but not for the extra employee payroll taxes. We do not find any evidence of labor supply responses along the extensive or intensive margins around the discontinuity, suggesting low efficiency costs of payroll taxes. We discuss various possible explanations for those results.