Saturday 15 September 2012

Social Security Contributions, wages and employment

The government's announcement of a change in Social Security Contributions raised a lot of fuss about a transfer from employers to employees. To recall, the government has announced an increase in employee's social security contributions of 7 pp from 11 to 18% and a decrease in employer's SSC of 5.75 pp from 23.75 to 18%. Almost everyone in the country seems to take it for granted that this will lead nominal net (of SSC) wages to decrease by 7 pp. A usual textbook argument about perfectly competitive markets would simply state that the legal incidence of the tax does not matter, and hence we should only worry about the overall increase in 1.25 pp. However, labor markets are far from being competitive and do not behave as in the simple textbook argument. A quick literature review suggests the following.
  1. The effects of SSC are very much context specific because they are not, strictly speaking, taxes (they entitle the workers to future income) and the precise way in which contributions are tied to benefits matters a lot for the behavioral responses.
  2. The overall tax increase is likely to be borne mostly by employees (i.e., net wages are expected to decrease by around half of the total SSC increase). Here is a reference on this.   Importantly, the shifting of the tax burden towards employees seems to be stronger when the perceived link between SSC and pension benefits is stronger.
  3. Estimating the impact of the nominal (or legal) sharing of the tax burden between employers and employees is difficult because of identification issues which are common to all the empirical literature on labor supply responses to tax changes. It is hard to disentangle changes in marginal and/or average tax rates on reported income from other non-tax factors such as unmeasured effort on the job, career choices, tax avoidance, and tax evasion. Exploiting a reform on SSC implemented in Greece in 92, which in a nutshell amounted to an increase in SSC of both employers and employees for high-wage earners, Emmanuel Saez and co-authors conclude the following. Firstly, labor supply is inelastic with respect to social security contributions. Secondly, the legal incidence of the SSC does matter, in the sense that the workers' net wage decreases following the increase in the employee SSC and the employers pay a higher gross wage following the increase in their own part of the SSC. While the authors themselves ask for caution in the generalization of their results to other contexts, this is still the best contribution that I know for the current debate.
 I do not resist to end with a citation of the paper cited above: "our results imply that employer vs. employee pay-roll tax cuts are likely to be sticky at least in the medium term. Under such nonstandard stickiness, reducing employer payroll taxes would increase profits while not affecting net wages, a desirable outcome when businesses face liquidity constraints to grow but an undesirable outcome when businesses are hoarding cash and reluctant to invest. In contrast, reducing employee payroll taxes would increase net wages without increasing profits, a desirable outcome to make
work more attractive or to stimulate aggregate consumption.

All in all, it seems that we will observe a transfer from workers to employers after all. This will contribute further to the decrease in the families' disposable income and to the number of private insolvencies in the country. Several questions remain. Will the positive effect of the decrease in SSC for employers outweigh the negative impact of the decrease in domestic demand? If they do, what will the firms do with increased profits? One has to be extremely careful about the non-tradables sector. So far, I haven't seen any policy announcement in this regard. The capacity of the government to regulate the firms in order to make them shift their eventual savings into more employment creation or price decreases is a fundamental political test which will shed light on whether this government is really catering for the special interests of a few firm share holders or the general interest. Let's wait and see.


  1. Thanks Susana. In my view the big Issue is whether everything has been done on the negotiation front. In fact I wonder as with the interest rate discussion last year (which initially was quite high and people took for granted to then see how it could in fact be lowered) whether Portugal could not negotiate better. The reason why I think we can do that is that 1) europe needs a success case 2) Portugal has shown it can be 'a good student' and 3) these measures will again not be enough. The alternative is in my view a bigger adjustment package with funds to alleviate corporate taxation and if possible provide more incentives (inclusive fiscal) to exporting corporations combined with admin expenditure reduction. At this stage I don't see how disposable income can be further reduced without a major recession which will lead to higher debt/GDP etc (let alone some of the other effects found in Latvia with massive emigration of talent). Finally one has to underline that the reduction in nominal wages is because of taxation and will therefore have no impact on competitiveness.

  2. Thanks indeed Susana. The evidence you cite, even if context specific as you remark, answers my question on wage rigidity and suggests that the fiscal devaluation through the swap in ssc between employers and employees can work.

    Nuno you are right: Portugal should try to obtain a lower interest rate on the loan. At least from the part that comes from the rest of Europe.

  3. Nuno,
    looking at the interest rate issue: it is a margin that might have already granted by our european partners: in late July 2012 the interest went from 5.5 to 3.5 with an extension of maturity from 7.5 years to a 15-30 years. I have checked the yield on a EFSF 25 years bond and it 3.47%.

  4. I failed to see how we can conclude that the proposed ssc swap can work, from what Susana writes. To my understanding, the last paragraph in the post is the most relevant: will increased profits be reinvested and will the contraction in income be compensated by lower prices? Too risky for macro policies. Best.

  5. Reducing Payroll Taxes? That is really interesting. I think that progressive countries might want to take things like that into consideration for the sake of their citizens especially for those who have low paying jobs.

    Sunday  Hindman