Labor taxation and unemployment

LABOR TAXATION AND UNEMPLOYMENT
AN EMPIRICAL INVESTIGATION

JUNE 2010 This publication was produced for review by the United States Agency for International Development. It was prepared by DAI.

LABOR TAXATION AND UNEMPLOYMENT
AN EMPIRICAL INVESTIGATION

Program Title: Sponsoring USAID Office: Contract Number: Contractor: Date of Publication: Author:

Fiscal Reform and EconomicGovernance USAID/EGAT, Office of Economic Growth GEG-I-06-04-00001-00 TO No. 06 DAI June 2010 Mark Gallagher

The authors’ views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.

CONTENTS INTRODUCTION......................................................................................................................... 1  CAPITAL, LABOR, TAXES, AND TECHNOLOGICAL CHOICE ............................................................ 2  TESTABLE HYPOTHESIS ............................................................................................................ 4  THE DATA................................................................................................................................. 4  ESTIMATING THE MODEL ........................................................................................................... 6  IMPLICATIONS ........................................................................................................................... 7  REFERENCES........................................................................................................................... 9  DATA APPENDIX ..................................................................................................................... 10 

FIGURES
Figure 1. The relationship between capital and labor use ............................................................................ 3 

TABLES
Table 1. Descriptivestatistics........................................................................................................................ 5  Table 2. Regression results .......................................................................................................................... 6 

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ABSTRACT
Applying cross-country regression analysis, this paper estimates the impact on unemployment rates of therelative tax on labor with respect to capital taxation. The study differs from earlier studies in two ways: it includes a much larger sample set, covering rich, middle income, and poor countries. Moreover, the outstanding independent variable is the ratio of the tax wedge on labor with respect to the company profit tax rate, rather than simply the tax wedge by itself, as the latter affectstechnological choice. The empirical results show that heavily taxing labor relative to capital leads to increased unemployment.

ACKNOWLEDGEMENTS
The author wishes to thank his colleagues, Art Mann, Steve Rozner, Christina Erickson, and Samira Salem, and Rachel Bahn for their review and comment on earlier versions of this paper. Of course, all errors and omissions are those of the author only.

viLABOR TAXATION AND UNEMPLOYMENT

LABOR TAXATION AND UNEMPLOYMENT
INTRODUCTION
A recent study of trends in international taxation by Norregaard and Khan (2008) highlighted the lowering of taxes on corporate profits, simplification of taxation, and the almost complete elimination of import duties as leading to enhanced public revenue generation. 1 Around the world, the introduction of the ValueAdded Tax (VAT) has been heralded as both the single most important and unifying tax reform. Moreover, especially in the developing world, governments have been seeking to spur investment and economic growth by lowering their tax rates on corporate or business profits. At the same time, many countries have also increased tax incentives to business. Additionally, a growing number of countries have...