The tax system incidence on unemployment: A country-specific analysis for the OECD economies

Abstract

In this paper we evaluate the incidence of the tax structure on the labor market. To do so we go beyond the traditional examination of the “level” effect of the fiscal wedge and consider a “composition” effect defined as a payroll tax bias (PTB): the proportion of payroll taxes paid by employees with respect to the one paid by firms. We develop a right-to-manage model encompassing different wage bargaining systems and the incidence of different types of taxes. Controlling for demand-side and supply-side determinants of unemployment, we show that the PTB plays a significant role in explaining unemployment in the continental European countries, but not in the Nordic nor in the Anglo-Saxon ones. We also show that there is no relationship between the incidence of the PTB and unemployment persistence, even though there is a positive relationship between unemployment persistence and the level of the fiscal wedge.