Regional payroll tax cuts and individual wages: heterogeneous effects of worker ability and firm productivity

Abstract

This paper exploits a payroll tax reform in Norway and applies matched employer–employee register data on individual wages to study the incidence of payroll taxation. The contribution is to allow for heterogeneous wage effects of payroll tax cuts based on unobserved worker ability and firm productivity (measured by estimated worker and firm fixed effects, respectively). Using the difference-in-difference approach, the estimates show that on average, about 30% of the labor cost reduction is shifted to employees through higher wages and the degree of tax shifting increases gradually during the first 3 years after the reform. Among high-productivity firms, the degree of tax shifting is stable at 40–50% throughout the post-reform period. In low-productivity firms, none of the labor cost reduction is shifted to employees in the short term, but there is a delayed wage response in the medium term. On average, the wage effect of reduced payroll taxes is twice as large in high-productivity compared to low-productivity firms. The difference in wage response is mainly between firms, rather than between workers within firms, although low-ability workers in low-productivity firms miss out on the wage gain from the reduced labor costs. The analysis does not find any robust employment effect of the payroll tax cut, neither in low- nor in high-productivity firms.