Pre-tax Wage Research Articles

Using payroll taxes as a redistribution tool

Payroll taxes are usually designed to fund social insurance and not to contribute directly to redistribution. Over the last fifty years, France has modified dramatically the schedule of payroll taxation, turning it into the most progressive part of its tax system. Using administrative data and detailed microsimulation model of labor income taxation, we show that pretax wage (or labor cost) inequality measured by the P90/P10 ratio has increased by 15.4%, while net wage inequality has actually decreased by 18.9% over the 1967–2019 period. This reduction in wage inequality can be largely attributed to the policy mix of reductions of employer payroll taxes for low wage earners joined with minimum wage increases. We discuss whether this unusual French experiment carries lessons for other countries.

Nonlinear taxation and international mobility in general equilibrium

Migration and general equilibrium forces are both known to limit the extent of redistribution due to a migration threat and a trickle-down rationale, respectively. In this paper, we consider these two forces jointly and study the optimal nonlinear taxation of internationally mobile workers in general equilibrium. We show that both forces partly offset each other. In general equilibrium, migration may lower the bottom tax rate but raises the top tax rate, challenging the classical migration-threat argument. Moreover, we demonstrate that migration responses weaken the trickle-down rationale. Both findings can be explained by a novel wage effect on migration and a migration effect on wages, calling for higher top tax rates to amplify pre-tax wage inequality and prevent high-skilled emigration. We calibrate our model to the U.S. economy and illustrate the new effects by comparing the optimal tax schemes with and without migration, as well as with and without endogeneity of wages.

Labor Taxation and the Uneven Growth of Wage Inequality

Abstract Wage inequality has risen in some rich countries but not others, and where it has risen, the divergence has been mainly between middle and high earners. I argue that taxation is an important factor driving this uneven growth of pretax wage inequality. In some countries, marginal tax rates on upper-middle incomes are high and stable, reducing the income that workers receive relative to the costs borne by employers. In others, marginal taxes on upper-middle incomes have been reduced, in some instances considerably, which incentivizes pretax income growth. I show that marginal tax rates are strongly correlated with pretax 90/10 and 90/50 wage ratios. The results are robust to alternative estimators that control for unobserved heterogeneity and other statistical issues. The findings suggest that, in an era of liberalized wage bargaining and decreased economic coordination, taxation may have taken on a greater role as an inequality-reducing institution.

Racial Disparities in Pre-tax Wages and Salaries in Largest Metropolitan Areas in the United States

The article deals with racial disparities in the distribution of pre-tax wages and salaries for employed individuals in the USA between the ages of 18-65. This study is done for the ten largest metropolitan areas of the USA using the 2019 American Community Survey data. The metropolitan areas included in the study are Atlanta-Sandy Springs-Roswell, Chicago-Naperville-Elgin, Dallas-Fort Worth-Arlington, Houston-The Woodlands-Sugar Land, Los Angeles-Long Beach-Anaheim, Miami-Fort Lauderdale-West Palm Beach, New York-Newark-Jersey City, Philadelphia-Camden-Wilmington, San Francisco-Oakland-Hayward, and Washington-Arlington-Alexandria. Employing well over a quarter of the total employed labour force in the USA, these ten metropolitan areas are also some of the largest industrial worlds. Average pre-tax wages and salaries, the standard deviation of the mean and Gini coefficient by major racial categories are presented for each of these ten metropolitan areas. For each metropolitan area, black employed individuals earned less in pre-tax wages and salaries than white employed individuals. The Gini coefficient of black pre-tax wages and wages is also found to be smaller for each of the metropolitan areas compared to the white counterparts. It suggests a much tighter distribution in pre-tax wages and salaries for blacks compared to whites. Furthermore, employed workers from other races earned less in pre-tax wages and salaries than their white counterparts for each major metro. Except for Los Angeles-Long Beach-Anaheim metropolitan area, black employed workers also earned less pre-tax wages and salaries than members of the other races. The Gini coefficients of pre-tax wages and salaries for various metropolitan areas for different races are found to be broadly comparable and often larger than that of the whites. Together, these results point to the fact that the pre-tax wages and salaries of black workers are lower compared to both whites and other races and more tightly distributed. Lastly, the relative inequality between whites and blacks and others and blacks often point to the relatively broader dispersion in the later group compared to the former.

Pre-Tax Wage and Salary Income Inequalities in Largest Metropolitan Areas in the United States

The distribution of pre-tax wages and salaries for employed individuals between the ages of 18-65 in the ten largest metropolitan areas of the USA are studied in this paper using the American Community Survey data from 2019. The included metropolitan areas are Atlanta-Sandy Springs-Roswell, Chicago–Naperville-Elgin, Dallas-Fort Worth-Arlington, Houston-The Woodlands-Sugar Land, Los Angeles-Long Beach-Anaheim, Miami-Fort Lauderdale-West Palm Beach, New York-Newark-Jersey City, Philadelphia-Camden-Wilmington, San Francisco-Oakland-Hayward, and Washington-Arlington-Alexandria. These ten metropolitan areas employed over 39 million individuals representing well over a quarter of the total employed labour force in the USA. Mean, median, standard error of the mean, 25th percentile, 50th percentile, and the Gini coefficient of pre-tax wages and salaries are presented for each metropolitan area. The metros differ significantly in terms of average pre-tax wages and salaries. They differ significantly in terms of the spread in the distribution of pre-tax wages and salaries measured both in terms of the inter-quartile range (the difference between 75th and 25th percentiles) and the Gini coefficient. San Francisco-Oakland-Hayward is found to have both the highest average pre-tax wages and salaries and widest inequality as measured by the Gini coefficient. The Smallest Gini coefficient is observed in Washington-Arlington-Alexandria metropolitan area. Inequality measured in terms of the Gini coefficient is nearly 15% higher in San Francisco-Oakland-Hayward as compared to Washington-Arlington-Alexandria. The average pre-tax wages and salaries are about 83% higher in San Francisco-Oakland-Hayward than Miami-Fort Lauderdale-West Palm Beach, the lowest in the nation. While aggregate nationwide inequalities attract intense attention, these regional variations point to significant and wide-ranging variations between different regions (metropolitan cities). By focusing on the pre-tax wages and salaries, this study allows us to tie inequalities that are most closely related to the labour market conditions, unlike other sources of income like capital gains, inheritance, government transfers, etc.

Nonlinear Taxation and International Mobility in General Equilibrium

We study the nonlinear taxation of internationally mobile workers in general equilibrium. Contrary to conventional wisdom, in general equilibrium, migration lowers the bottom tax rate but raises the top tax rate, making the optimal tax system more progressive and moving tax rates closer to those in an economy with fixed wages. The intuition is that governments attract high-skilled workers by amplifying pre-tax wage inequality and partly offsetting trickle-down forces from production complementarities. This finding raises doubts about the importance of trickle-down for optimal taxation and offers a novel explanation for why globalization may increase tax progressivity and wage inequality.

Wage inequality, labor income taxes, and the notion of social status

Abstract The authors investigate the desirability of income taxes when the objective is to mitigate wasteful conspicuous consumption generated by people's status-seeking behavior. They consider the joint role of pre-tax wage inequality and of social norms determining how social status is assigned. They find that when social status is ordinal (i.e., only one's rank in the income distribution matters) inequality and taxation are substitutes. Instead, when status is cardinal (i.e., also the shape of the income distribution matters) inequality and taxation can be complements, although the relationship is in general non-monotonic. This is because the value of social status is endogenous, potentially giving rise to a perverse selfreinforcing mechanism where more waste in conspicuous consumption induces a greater competition for status and vice versa.

Structural Reform in Germany

This paper provides a quantitative evaluation of the macroeconomic, distributional, and fiscal effects of three reform proposals for Germany: i) a reduction in the social security tax in the low-wage sector, ii) a publicly financed expansion of full-day child care and full-day schooling, and iii) the further deregulation of the professional services sector. The analysis is based on a macroeconomic model with physical capital, human capital, job search, and household heterogeneity. All three reforms have positive short-run and long-run effects on employment, wages, and output. The quantitative effects of the deregulation reform are relatively small due to the smal size of professional services in Germany. Policy reforms i) and ii) have substantial macroeconomic effects and positive distributional consequences. Ten years after implementation, reforms i) and ii) taken together increase employment by 1.6 percent, potential output by 1.5 percent, real hourly pre-tax wages in the low-wage sector by 3 percent, and real hourly pre-tax wages of women with children by 2.7 percent. The two reforms create fiscal deficits in the short run, but they also generate substantial fiscal surpluses in the long-run. They are fiscally efficient in the sense that the present value of short-term fiscal deficits and long-term surpluses is positive for any interest (discount) rate less than 9 percent.

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Public Goods, Labor Supply and the Source of Economic Distortions

According to the traditional public finance literature any tax instrument other than the lump-sum tax is inherently distortionary because it alters relative prices. This paper revisits the case of the labor income tax and shows that its supposedly distortionary effects are the result of a stringent assumption about labor supply behavior. The conventional time allocation model generally assumes that taxpayers disregard the marginal benefits of taxation, received in the form of additional public goods, in their labor supply responses to the labor income tax. In line with previous literature stressing the importance of government spending for labor supply behavior, this paper generalizes the time allocation model by describing the behavior of taxpayers that consider both the marginal costs and the marginal benefits of the labor income tax. Under this (more general) framework the paper derives an efficient (undistorted) solution to the problem of determining the optimal amount of public goods, where taxpayers contribute to the public goods in accordance to their individual marginal benefits while the relative value of leisure remains equal to the pre-tax wage rate.

A Simple Theory of Optimal Redistributive Taxation withEquilibrium Unemployment

We consider an optimal nonlinear income tax problem in a model with search-matching unemployment and where the negotiated pre-tax wage decreases with marginal tax rate but increases with the level of tax. By omitting labor supply Responses, assuming no benefit for the unemployed and an efficient allocation in the absence of tax, we characterize the optimal equity-efficiency trade off. We show that in labor market specific to each interior level of skill, optimal wages and unemployment rates are distorted downwards. Moreover, average tax rate are increasing along the income distribution and marginal tax rate are positive at the top, even when the skill distribution is bonded.

Does Indivisible Labor Explain the Difference between Micro and Macro Elasticities? A Meta-Analysis of Extensive Margin Elasticities

Macroeconomic calibrations imply much larger labor supply elasticities than microeconometric studies. One prominent explanation for this divergence is that indivisible labor generates extensive margin responses that are not captured in micro studies of hours choices. We evaluate whether existing calibrations of macro models are consistent with micro evidence on extensive margin responses using two approaches. First, we use a standard calibrated macro model to simulate the impacts of tax policy changes on labor supply. Second, we present a metaanalysis of quasi-experimental estimates of extensive margin elasticities. We find that micro estimates are consistent with macro evidence on the steady-state (Hicksian) elasticities relevant for cross-country comparisons. However, micro estimates of extensive-margin elasticities are an order of magnitude smaller than the values needed to explain business cycle fluctuations in aggregate hours. Hence, indivisible labor supply does not explain the large gap between micro and macro estimates of intertemporal substitution (Frisch) elasticities. Our synthesis of the micro evidence points to Hicksian elasticities of 0.3 on the intensive and 0.25 on the extensive margin and Frisch elasticities of 0.5 on the intensive and 0.25 on the extensive margin.

Quantifying the Role of Federal and State Taxes in Mitigating Wage Inequality

Wage inequality has risen dramatically in the United States since at least 1980. This paper quantifies the role that the tax policies of the federal and state governments have played in mitigating wage inequality. The analysis, which isolates the contribution of federal taxes and state taxes separately, employs two approaches. First, cross-sectional estimates compare before-tax and after-tax inequality across the 50 states and the District of Columbia. Second, inequality estimates across time are calculated to assess the evolution of the effects of tax policies. The results from the first approach indicate that the tax code reduces wage inequality substantially in all states. On average, taxes reverse approximately the last two decades of growth in wage inequality. Most of this compression of the income distribution is attributable to federal taxes. Nevertheless, there is substantial cross-state variation in the extent to which state tax policies compress the income distribution. Cross-state differences in gasoline taxes have a surprisingly large impact on income compression, as do sales tax exemptions for food and clothing. The results of the second approach indicate that the mitigating influence of tax policy on wage inequality has increased very modestly since the early 1980s. The increase is due to the widening of the pre-tax wage distribution interacting with a progressive tax structure. In contrast, legislated tax changes over this period decreased income compression somewhat.

Do Redistributive State Taxes Reduce Inequality?

Do income taxes levied at a state or regional level affect the after-tax distribution of income? Or do workers merely move between regions, causing pre-tax wages to adjust? Using the full income tax parameters for all U.S. states from 1977-2002, I create a "simulated tax redistribution index" that captures the mechanical impact of changes in tax policy on the Gini coefficient, hut is exogenous to any behavioral response. Analyzing the effect of this redistribution index on inequality, I find that gross wages do not adjust so as to undo the effect of changes in state income taxes. On aggregate, more redistributive state taxes do not substantially affect interstate migration, nor do they reduce per-capita state personal income.

On the Optimality of Search Matching Equilibrium When Workers Are Risk Averse

AbstractThis paper revisits the normative properties of search‐matching economies when homogeneous workers have concave utility functions and wages are bargained over. The optimal allocation of resources is characterized first when information is perfect and second when search effort is not observable. In the former case, employees should be unable to extract a rent. The optimal marginal tax rate is then 100%. As search effort becomes unobservable, an appropriate positive rent is needed and the optimal marginal tax rate is lower. Moreover, the pretax wage is lower in order to boost labor demand. Finally, in both cases, nonlinear income taxation is a key complement to unemployment insurance.

On Tax Over-Shifting in Wage Bargaining Models

It has frequently been noted in the wage bargaining literature that increasing average labour taxes may in fact be over-shifted in the pre-tax wage that is negotiated between unions and firms, raising workers post-tax wages. In this paper, we study the precise conditions for such tax over-shifting to occur under both Nash and Right-To-Manage bargaining structures, and considering both competitive and imperfectly competitive output market conditions. In the case of competitive output markets, we derive and interpret the conditions for over-shifting to occur and show that they hold for an entire class of commonly used production functions. Moreover, under monopolistically competitive output markets we show that tax over-shifting will occur when the firm has sufficient market power. The conditions on the production function, that were necessary and sufficient for tax over-shifting to occur under perfect competition, are shown to be no longer necessary. These findings hold for all bargaining structures considered.

The Impact of Payroll Tax Reductions on Employment and Wages: A Natural Experiment using Firm Level Data

Past evidence on the incidence of payroll tax subsidies on employment and wages for disadvantaged workers has been quite mixed. Therefore, this paper makes use of a unique panel of firm level data and a natural experiment to analyze the incidence of wage subsidies on full-time manual workers and pre-tax wages. Using a number of straightforward evaluation estimators we find that employment subsidies increased full-time manual employment and pre-tax wages. Moreover, we find that employment subsidies have increased employment but not wages by more in low-wage exporting industries. This is line with a textbook description of labor markets where it is predicted that the incidence of employment subsidies on employment and wages is larger the more elastic is product and therefore labor demand and where the employment effect is larger and the wage effect is smaller the more elastic is labor supply because of a binding minimum wage.

Progressive taxation and wage setting when unions strategically interact

In a multisector economy with unionized labor markets, the interdependence of union wage claims--typical of industrial bargaining--affects the relationship between tax progressivity and wage pressure, which varies in a nonlinear fashion with the nature of the wage bargain, and can be hump-shaped. Our empirical analysis of 20 OECD countries for the period 1997--2004 shows that higher tax progressivity increases pre-tax wages (and unemployment) in countries characterized by industry level wage bargaining, and reduces them in countries with local or fully centralized bargaining. Copyright 2007, Oxford University Press.

Can Redistributive State Taxes Reduce Inequality?

Do income taxes levied at a state or regional level affect the after-tax distribution of income? Or do workers merely move between regions, causing pre-tax wages to adjust? This question is relevant both in across states in the United States, and across countries within the European Union. Using the full income tax parameters for all US states from 1977-2002, I create a simulated tax redistribution index, which captures the mechanical impact of the changes in tax policy on the gini coefficient, but is exogenous to any behavioral response. Analyzing the effect of this redistribution index on inequality, I find that gross wages do not adjust so as to fully offset the effect of more redistributive taxes. Exploring the adjustment process further, I create a new class of tax redistribution measures, based on the S-Gini, which differentially weight effects at the bottom and top of the distribution, and conclude that neither taxes that particularly affect the rich or the poor seem to affect the distribution of wages. Redistributive taxes do not appear to affect interstate migration or total state personal income. From a political economy perspective, I also find some evidence that more inequality leads states to implement more redistributive taxes, which may help explain why earlier studies observed a positive relationship between redistribution and inequality.

Tax-Transfer Policy and Labor-Market Outcomes

The Earned Income Tax Credit provides nearly $40 billion to low-income families with children. A potential unintended consequence of the credit is lower pretax wages, in which case only part of the subsidy would accrue to workers. We examine the extent to which EITC expansions lower the pretax wages of working parents. Our findings are inconclusive. The gross hourly wages of less-skilled single women are found not to vary by the number of children, as does the EITC. In addition, the wages of black single mothers track the minimum wage for nearly the entire time period.