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EMPLOYMENT EFFECTS OF TAX CUTS: THE CASE OF SERBIA

EMPLOYMENT EFFECTS OF TAX CUTS: THE CASE OF SERBIA. Jelena Žarković Rakić Faculty of Economics and FREN University of Belgrade. Motivation. Since 2000 Serbia experienced relatively high GDP growth rates At the same time, employment rates rather low, even negative

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EMPLOYMENT EFFECTS OF TAX CUTS: THE CASE OF SERBIA

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  1. EMPLOYMENT EFFECTS OF TAX CUTS: THE CASE OF SERBIA Jelena Žarković Rakić Faculty of Economics and FREN University of Belgrade

  2. Motivation • Since 2000 Serbia experienced relatively high GDP growth rates • At the same time, employment rates rather low, even negative • Which factors prevent job creation in the economy?

  3. Motivation • Focus on labor taxes (labor tax wedge) • Policy recommendation of the OECD Jobs Study : • "Reduce non-wage labour costs, especially in Europe, by reducing taxes on labour ..." • "Reduce direct taxes (social security and income taxes) on those with low earnings Labor taxes Labor costs

  4. Tax-employment link in Serbia • Arandarenko and Stanic (2006):tax wedge in Serbia accounts for about 40% of total labor costs on average

  5. Tax-employment link in Serbia • Arandarenko and Vukojevic (2008): • found rather low (short-run) elasticity of labor costs with respect to labor demand • negative. but not significant impact of labor tax wedge on employment level

  6. Contribution • Find evidence for tax-employment link at the micro level in Serbia • Show that policy aimed at reducing labor taxes for workers of certain skill categories would be more favorable for employment than across-the-board-tax cuts • To justify selective labor tax reductions across skill types, focus on tax-shifting phenomena

  7. Tax shifting • Tax shifting exists when legal tax incidence (i.e. who writes the check to pay a tax) differs from actual economic burden of the tax (i.e. whose real income is lowered) • Increase in SSC, legally borne by employers, are passed on to workers as lower wages, or, wage increase as a result of SSC reductions

  8. Tax shifting • Gruber (1997): • large reduction in SSC was fully shifted onto higher wages with no positive effects on employment • Korkeamaki and Uusitalo (2006): • increase in wages offset roughly half of the impact of the SSC cut on the labour costs • Kugler and Kugler (2008): • 1/5 of SSC increase was shifted onto lower wages. Less shifting for production (low-skilled) workers. • Taymaz (2007): • also founds lower degree of shifting for low wage earners

  9. Empirical model • Dynamic employment equation is in the panel data form: with i=1,…,N; t=1,…,T whereNit is the number of employees in the establishment i and year t, wit is the real product wage (labor costs), kit is the capital stock and qit is the output

  10. Empirical model • The same model is estimated separately for high-skill and low-skilled workers:

  11. Empirical model • How wages respond to changes in taxation - wage equation: • Coefficient of the variable stands for the ratio between employers’ social security contributions and gross wage (SSC rate); measures the level of tax-shifting • number of minimum wage earners in the labor force, minimum wage and kl capital-labor ratio.

  12. Data • The sample consists of a panel of manufacturing firms observed for the period 2002-2007 • Firms classified into several industrial groupings: capital goods and consumer durables, consumer goods and intermediate products.

  13. Estimation method • All equations have dynamic form since they include lagged dependent variable on the right-hand side • In case of dynamic models, standard panel estimation techniques would produce biased and inconsistent estimates • Following Blundell and Bond (1998), we chose system GMM

  14. Estimation results: total employment • Coefficient of lagged labor demand variable measures how rapidly labor demand adjust to a shock in product demand or factor prices • It takes about 1.9 years to move halfway to the eventual equilibrium employment level → low flexibility of labor market • Long run wage elasticity of -0.76 → employment adjust strongly to change in labor costs ** signif. at 5%., *** signif. at 1%.

  15. Estimation results: employment by skill

  16. Estimation results: wage equation • Adjustment of wages is finished in about 9 months • In the long run, 1% drop in SSC lead to 1.5% rise in average wage • Average wage would rise by 0.4% due to 1% rise in minimum wage • 1% rise in the number of employees working at minimum wage level leads to a 0.23 % drop in average wage

  17. Estimation results: wage equation by skill

  18. Conclusion • Tax cuts can boost employment but not to a great extent • Estimation results indicate more than full shifting to wages in case of high-skilled workers • Pass through effect is lower for low-wage earners. Reduction in social security contributions from current 17.9% to a 7.9% may reduce labour costs of labour costs of blue collar workers by 1.4 % and increase their employment in the long run by 0.83%. • Results provide support for the argument that the employment effects of payroll tax cuts would be more effective in the case of selective tax reductions (only to low-wage earners) instead of applying the general tax cuts

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