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The Effect of the Payroll Tax on Earnings: A Test of Competing Models of Wage Determination

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  • Kevin Lang

Abstract

Under the standard competitive model, if a tax change affects a group of workers with highly inelastic labor supply, their earnings will fall by essentially the entire nominal employer share of the tax increase. Allowing the wage to play a motivational role but maintaining the market-clearing assumption broadens the range of possible outcomes. With a 50/50 split in the nominal share, given a reasonable estimate of the elasticity of demand, earnings could fall from anywhere between 0 and more than 100% of the employer's nominal share but would not rise. In contrast, because there is excess labor (involuntary unemployment) in equilibrium, efficiency wage models function very much like models in which the supply of labor is perfectly elastic, and thus earnings rise by more than the worker's nominal share. I argue that the 1968, 1974 and 1979 increases in the taxable earnings base for FICA provide good opportunities to test the models. This tax increase affected only those workers earning significantly more than the median earnings for male full-time/year-round workers. Such workers' labor force participation is likely to have been highly inelastic. In addition, low earnings workers did not experience this tax increase. I examine the effects of the earnings base increases using data from the March CPS and from the PSID. The results are supportive of models in which the motivational effects of wages are important but cannot clearly distinguish between the efficiency wage and market-clearing versions of those models

Suggested Citation

  • Kevin Lang, 2004. "The Effect of the Payroll Tax on Earnings: A Test of Competing Models of Wage Determination," Econometric Society 2004 North American Winter Meetings 360, Econometric Society.
  • Handle: RePEc:ecm:nawm04:360
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    References listed on IDEAS

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    1. Pisauro, Giuseppe, 1991. "The effect of taxes on labour in efficiency wage models," Journal of Public Economics, Elsevier, vol. 46(3), pages 329-345, December.
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    Cited by:

    1. Kugler, Adriana & Kugler, Maurice, 2003. "The Labor Market Effects of Payroll Taxes in a Middle-Income Country: Evidence from Colombia," IZA Discussion Papers 852, Institute for the Study of Labor (IZA).
    2. Aziza GARSAA & Nadine LEVRATTO & Luc TESSIER, 2015. "Do Exemptions From Social Security Contributions Affect Job Creation? New Empirical Evidence From French Overseas Regions," Region et Developpement, Region et Developpement, LEAD, Universite du Sud - Toulon Var, vol. 42, pages 79-104.
    3. Kugler, Adriana & Kugler, Maurice, 2003. "The labor market effects of payroll taxes in a middle-income country: evidence from Colombia," Discussion Paper Series In Economics And Econometrics 0306, Economics Division, School of Social Sciences, University of Southampton.
    4. Libor Dušek & Petr Janský, 2012. "Dopady změn daně z přidané hodnoty na reálné příjmy domácností
      [The Impact of VAT Changes on the Households´ Real Incomes]
      ," Politická ekonomie, University of Economics, Prague, vol. 2012(3), pages 309-329.
    5. repec:kap:decono:v:165:y:2017:i:2:d:10.1007_s10645-017-9294-7 is not listed on IDEAS
    6. Facundo Alvaredo & Thomas Breda & Barra Roantree & Emmanuel Saez, 2017. "Contribution Ceilings and the Incidence of Payroll Taxes," De Economist, Springer, vol. 165(2), pages 129-140, June.
    7. Michael Neumann, 2015. "Earnings Responses to Social Security Contributions," Discussion Papers of DIW Berlin 1489, DIW Berlin, German Institute for Economic Research.

    More about this item

    Keywords

    wage determination; efficiency wage; incentives;

    JEL classification:

    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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