Visibility of social security contributions and employment

1. Visibility of social security contributions and employment Iñigo Iturbe-Ormaetxe Universidad de Alicante PET10, Istanbul, June 2010

2. Goal of the paper • In most countries social security contributions are split between workers and firms • Average total contribution for the OECD is 23.8% • Average firm contribution is 15.2%, and average worker contribution is 8.6%. An split of around 64-36 PET2010, Istanbul

3. PET2010, Istanbul

4. Economic incidence • Without minimum wages, standard economic analysis predicts that it does not matter who nominally pays the tax (statutory incidence) • Economic incidence depends only on the elasticities of labor demand and labor supply PET2010, Istanbul

5. Goal of the paper-2 • Suppose, in particular, that we need to raise contributions. We know this will hurt employment • However, it is irrelevant whether we raise employers contributions or employees contributions, as long as the change is the same • Additionally, any change in how contributions are split has no effect on employment or on the cost of labor PET2010, Istanbul

6. Goal of the paper-3 • I depart from standard analysis in two directions: • First, I consider that workers perceive some linkage between contributions and future benefits (as in Summers 1989) • Second, I assume that workers value more contributions paid by themselves than those paid by the firm. The reason is that the latter are less “visible” for workers PET2010, Istanbul

7. Results • Under the two assumptions above, I find that changes in contributions paid by firms have more impact on employment than similar changes in contributions paid by workers • As a consequence any change in how contributions are split, that keeps constant total contributions while reducing the share of the firm, has a positive effect on employment PET2010, Istanbul

8. Results-2 • Intuition: firms perceive contributions as pure taxes while workers perceive some linkage with future benefits • Reducing the share of firms is positive for employment • Increasing the share of workers is negative for employment. However, this raises the “visible” part of contributions, partially offsetting this negative effect PET2010, Istanbul

9. Results-3 • Overall, the effect on employment is positive • I do not need minimum wages to get this result • Another interesting result is that policy changes that increase visibility of contributions have always a positive effect on employment PET2010, Istanbul

10. Competitive equilibrium • Labor demand is D(w(1+F)), where F is the contribution rate paid by firms • Labor supply is S(w), where:  = 1- W + (W+F) • Here W is worker’s contribution rate and total tax rate is  = F + W • The parameter   0 captures the strength of the linkage workers perceive between contributions and benefits PET2010, Istanbul

11. Competitive equilibrium • If  = 0, workers perceive all contributions as pure taxes • If benefits are strictly proportional to contributions, all workers will have similar values of  • If the system is progressive, low-skilled workers will have higher values of  than high-skilled workers PET2010, Istanbul

12. Competitive equilibrium • Recall that  = 1- W + (W+F) • The parameter   [0,1] represents how “visible” are contributions paid by employers • If  = 1 they are equally visible than those paid by workers themselves • If  = 0 they are not visible at all PET2010, Istanbul

13. Boeri, Börsch-Supan, Tabellini PET2010, Istanbul

14. Visibility • My interpretation is that workers have little information about contributions paid by firms • Or, at least, they are more myopic with respect to contributions paid by firms • This is what I need to derive my results PET2010, Istanbul

15. Analysis • I analyze the effect of changes in F and W on employment (L) • To do this, I compute dlnL/dF and dlnL/dW. Both are negative • However, the size of dlnL/dF is larger than the one of dlnL/dW as long as: PET2010, Istanbul

16. Analysis-2 • Assume that  = 20% • If  = 0.5, the condition is  < 0.8 • If  = 0.75, the condition is  < 0.93 • If  = 1, the condition is  < 1 • If the system is progressive, the condition is more likely to hold for low-skilled workers (high  and low ) PET2010, Istanbul

17. Illustration of the condition  1 Here ’ >  ’/(1+’) /(1+)  PET2010, Istanbul

18. Analysis-3 • Next I consider a policy change such that dF = -dW < 0 • Total contributions  remain unchanged • Under the above condition, this change has a positive effect on employment • It also reduces total labor costs for firms PET2010, Istanbul

19. Policy change S(w) S(w) wF ww D(w) D(w(1+F)) PET2010, Istanbul

20. Policy change-2 S(’w) S(w) S(w) wF wF’ ww’ ww D(w) D(w(1+F)) D(w(1+F’)) PET2010, Istanbul

21. Increasing visibility • Government could require firms to provide detailed information about contributions • In Spain, for example, this information IS NOT in the monthly wage report (pay slip) • As long as  > 0, this has always a positive effect on employment • It also reduces labor costs PET2010, Istanbul

22. Increasing visibility S(w) S(w) wF ww D(w) D(w(1+F)) L PET2010, Istanbul

23. Increasing visibility S(’w) S(w) S(w) wF wF’ ww’ ww D(w) D(w(1+F)) L L’ PET2010, Istanbul