Unemployment, growth and taxation in industrial countries

In Europe, labor costs have gone up for many reasons, but one is particularly easy to identify: higher taxes on labor. If wages are set by strong and decentralized trade unions, an increase in labor taxes is shifted onto higher real wages. This has two effects. First, it reduces labor demand, and th...

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Bibliographic Details
Published in:Economic policy 2000-04, Vol.15 (30), p.47-104
Main Authors: Daveri, Francesco, Tabellini, Guido
Format: Article
Language:English
Subjects:
Economic growth
Economic models
Economic policy
Industrialized nations
Real wages
Studies
Tax rates
Unemployment
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Summary:In Europe, labor costs have gone up for many reasons, but one is particularly easy to identify: higher taxes on labor. If wages are set by strong and decentralized trade unions, an increase in labor taxes is shifted onto higher real wages. This has two effects. First, it reduces labor demand, and thus creates unemployment. Secondly, as firms substitute capital for labor, the marginal product of capital falls; over long periods of time, this in turn diminishes the incentive to invest and grow. According to our estimates, the observed rise of 14 percentage points in labor tax rates between 1965 and 1995 in the EU could account for a rise in EU unemployment of roughly 4 percentage points, a reduction of the investment share of output of about 3 percentage points, and a growth slowdown of about 0.4 percentage points a year.
ISSN:0266-4658
1468-0327
DOI:10.1111/1468-0327.00057