A report published by the European Commission on 31 May 1999 estimates the job-creation potential of a reduction in non-wage labour costs, with an accompanying reduction in public expenditure, to be approximately 1%. The report shows that average EU non-wage labour costs are significantly higher than in the USA and demonstrates different models of offsetting the drop in revenue caused by a reduction in taxes on labour. The document serves to highlight the complexities of such a strategy.
The reduction of taxation on labour and other non-wage labour costs has been part of the European Commission's strategy to raise employment for almost five years, as it is considered that high non-wage labour costs, particularly on low-paid labour, are leading to high rates of unemployment among low-skilled workers and are encouraging clandestine, undeclared activity. The Commission's 1999 Broad Economic Policy Guidelines re-emphasised the importance of Member States' reducing taxes, particularly on low-paid labour. It is intended that this reduction in taxation of labour be offset by new taxes or tax increases on environmental pollution, energy or consumption. The social partners are similarly called upon to commit themselves to control wage and other non-wage costs, as a contribution to the European employment strategy. The draft Broad Economic Policy Guidelines estimate that, with an average rate of 43% of GDP, the tax burden in the European Union in 13% higher than in the USA. The tax burden indeed exceeds 40% in most of the EU Member States, with only Ireland being comparable with the USA in this respect. Despite the fact that the effective tax rate on labour and the labour "tax wedge" have declined in the EU since 1994, the level of the "tax wedge" indicates that around 50% of the gross wage is absorbed by taxes in a number of EU Member States,
The impact of further reduction in non-wage labour costs
On 31 May 1999, the Commission's services assisting the EU's Economic and Finance Committee issued a report entitled Employment and the reduction in non-wage labour costs. This working document estimates that an across-the-board reduction in non-wage labour costs of around 1% of GDP, accompanied by a similar reduction in state expenditure, would lead to an increase in long-term employment of approximately 1%. The authors of the report argue that if this reduction in non-wage labour costs were offset by a cut in global expenditure by the Member States, the long-term positive impact on employment would be slightly higher at around 1.3%. However, if the reduction were to be offset by an increase in VAT, the employment effect would be reduced to 0.6%.
Clearly, a reduction in non-wage labour costs would have to be offset in some way to ensure a balancing of the budget. A reduction in social benefits aimed at funding the reduction of the cost of employing a low-skilled worker is considered to be politically unworkable. The reduction in non-wage labour costs therefore has to be offset by spending cuts in other areas or by increases in other taxes. However, it is argued that the latter could have damaging inflationary effects.
The report finds that in terms of gross wages, non-wage labour costs account for 25% of the total paybill in the European Union (30% for the countries covered by the euro single currency). Only in Denmark, Ireland and the United Kingdom are non-wage labour costs lower than in the USA (where they stand at 15% of paybill). In countries such as Germany, France, the Netherlands and Austria, the rate is even higher at 30%. Although non-wage labour costs have fallen by 0.6% since 1994, they have indeed risen by 5% of the wage bill in the past two decades.
Taking into account that the main concern revolves around the non-wage labour costs of low-skilled and low-paid individuals, the report uses data provided by the Organisation for Economic Cooperation and Development (OECD) for 1996 to show that non-wage labour costs for the low paid are particularly high. In Belgium, France, Germany, Greece, Italy, the Netherlands and Austria, non-wage labour costs account for between 30% and 40% of the paybill among the low paid. If the incidence of personal income tax is taken into account, the direct tax burden borne by the low-paid increases to between 40% and 50% in many Member States. The report finds that low-skilled workers in the EU bear a tax burden of 42%, whereas the equivalent figure in the USA is 30%. Only in the UK and Ireland is the tax burden on the low-skilled, at 26%, lower than in the USA.
The working document calculates different options for the reduction of non-wage labour costs and different methods for offsetting these, reaching the conclusion that these would lead to an average increase in long-term employment of 1%.
Commentary
The reduction of non-wage labour costs, particularly for low-skilled individuals, has long been on the agenda of EU and Member State labour market policy. However, such policies contain many imponderables, particularly in relation to how the shortfall in revenue could be offset. It has been argued that the resulting reduction in unemployment would have the result of relieving the pressure on the public purse in terms of social benefit expenditure. However, the level of pay offered by the employment thus created would need to be taken into account: as incentive effects may be low, the "benefits trap" may discourage movement into employment, making the payment of benefits to those in work necessary. The prospect of an accompanying increase in taxes on items such as energy or environmental pollution always sends alarm bells ringing among employers, which argue that such moves would in themselves cost jobs. Whatever measure is proposed, it is crucial that any side-effects are clearly studied and understood if its impact is not to be detrimental. The new report, rather than clarifying the situation, shows the potential pitfalls contained in different strategies and highlights why progress in this debate has been slow in coming. (Tina Weber, ECOTEC Research and Consulting)