Wage Bargaining Coordination, Taxation and Labor Costs: The Effects of Fiscal Devaluation

This study empirically investigates the effects of fiscal devaluation—i.e., a tax shift from employers’ social security contributions to value added tax—on real labor costs on a sample of 23 countries, members of the European Union, over the period between 2001 and 2018. Our results show that fiscal devaluation indeed reduces real labor costs, as suggested in the literature on fiscal devaluations. The effects turn out to be the strongest, and mostly statistically significant, for countries with intermediate and low degrees of wage bargaining coordination, stressing the importance of labor market institutions. For these countries, we find that both value added tax hikes and cuts in employers’ social security contributions help to reduce real labor costs. Countries with a high degree of wage bargaining coordination, where the impact of fiscal devaluation is weaker, should be able to influence real labor costs via coordinated incomes policy, so that the potentially needed labor costs adjustments can be managed even without the implementation of fiscal devaluations.