Labour Force Participation and Tax-Benefit Systems: A Cross-Country Comparative Perspective

This paper investigates the extent to which cross-country differences in aggregate participation rates can be explained by divergence in tax-benefit systems. We take the example of two countries, the Czech Republic and Hungary, which – despite a lot of similarities – differ markedly in labour force participation rates. We use, for both countries, a very detailed, complex microsimulation model and perfectly comparable micro estimates of labour supply at the extensive margin (i.e. the participation decision) to quantify the portion of the divergence in the two countries’ participation rates explained by differences in their taxation and welfare benefit systems.we first replicate for Czech individual level data the labour supply estimation for Hungary presented in Benczúr et al. (2014). The two entirely comparable estimated equations for the Czech Republic and Hungary are then used to simulate how the aggregate participation rate would change in one country if it adopted the other country’s tax and social welfare system.Our results show that the estimated labour supply elasticities for the Czech Republic are very close to the results for Hungary, suggesting that, at least in this dimension, individual preferences are similar in the two countries. This holds true even for sub-populations depending on the level of education, gender and marital status: in both countries, lower educated people, the elderly and married women (of childbearing age) are the most responsive to tax and transfer changes. Second, the simulation results suggest that about one-half of the total difference in the participation rates of the 15–74 years old population can be explained by differences in the tax-benefit systems. The results are quasi-symmetric, meaning that if the Czech system was adopted, the Hungarian participation rate would increase by about the same number of percentage points that the Czech participation would decrease by if the Hungarian system were implemented. The highest responses are obtained for married women and women of childbearing age. This is related to the more generous maternity benefit system in place in Hungary as compared to the Czech Republic.