Distortionary Taxation and Labour Market Performance
| Author | Flavio Padrini,Riccardo Fiorito |
| Published date | 01 May 2001 |
| Date | 01 May 2001 |
| DOI | http://doi.org/10.1111/1468-0084.00215 |
Distortionary taxation and labour market
performancey
Riccar do Fiorito and Flavio Padrini
Dipartimento di Economia Politica, Universita
Ádi Siena, Piazza San Francesco 7,
53100 Siena, Italy (e/mail: r®orito@iol.it);
Ministero del Tesoro, via XX Settembre 97, 00187 Rome, Italy
(e/mail: ¯avio.padrini@tesoro.it).
I. Introduction
In this study, we construct quarterly estimates of consumption, labour and
capital tax rates for Canada, the United States, Germany, France, the United
Kingdom and Italy mainly following the methodology devised for annual
data by Mendoza, Razin and Tesar (1994) (henceforth, MRT). Then, we use
the `stylized facts' methodology (Kydland and Prescott, 1990) to evaluate the
strength, sign and phase of the cyclical comovements between the estimated
tax rates and the relevant labour market variables in each country. Finally, we
provide a preliminary structural analysis to assess whether consumption and
factor tax rates are related to labour market performance in all countries.
Our sample refers to major OECD economies for which unemployment is
an important issue and, in practice, corresponds to the G7 economies without
Japan, i.e. to a group of countries displaying business cycles features that are
fairly similar unless labour market and policy variables are considered
(Fiorito and Kollintzas, 1994). A second reason for considering these six
countries is that they roughly correspond to the rigid labour markets of
`continental Europe' (France, Germany and Italy) and to the admittedly more
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 63, 2 (2001) 0305-9049
#Blackwell Publishers Ltd, 2001. Published byBlackwell Publishers, 108 Cowley Road, Oxford OX4 1JF, UKand 350
Main Street, Malden, MA 02148, USA.
173
yThe opinions expressed here are strictly personal and do not represent the views of the Italian
Ministry of the Treasury or any other institution. Fiorito started his work whilevisiting the Research
Department of the IMF whose hospitality was friendly and inspiring. We thank Mike Artis, an
anonymous referee and the participants at an EUI seminar in Florence and at the 1999 Villa
Mondragone Conference in Rome for their useful comments. Obviously,we retain full responsibility
for any remaining error. CNR funding is gratefully acknowledged.
¯exible product and labour markets of the `Anglo-Saxon' countries (US,
Canada and the UK).
We do not consider explicitly the role of labour market institutions in
explaining different unemployment rates (Nickell and Layard, 1999). We
focus instead on the role of product and factor taxation for the representative
agent. Hence, our labour tax rates are not con®ned to payroll taxes but
include (progressive) labour income taxation while capital tax rates apply to
all types of nonlabour income.
We should note at the outset that our tax rates, like those presented by
MRT, are actual or average tax rates rather than marginal tax rates, which
might seem more relevant to evaluate the impact of taxation on the growth of
the economy (Koester and Kormendi, 1989). However, this point should not
be overstated for several reasons: ®rst, average and marginal tax rates are
considerably correlated as shown by the OECD estimates used by Nickell
and Layard (1999).1Second, in our stylized fact analysis we use cyclical
deviations from the trend, i.e. cyclical components of the estimated tax rates
that are compared with cyclical deviations of the labour market variables.
Finally, marginal tax rates are plagued by larger measurement errors than
effective tax rates.
Unemployment is not considered here as the negative of employment but
rather as the result of both labour force and employment decisions (Fiorito
and Padrini, 1993). Accordingly, the labour force rather than worked hours
has been chosen to approximate labour supply. Since population changes are
comparatively small at business cycle frequencies, our cyclical deviations
should approximate the comovements between the participation rate and
factor tax rates suf®ciently well.
We separate labour supply into female and male components because
empirical studies generally show that the substitution effect is higher for
women and smaller or negligible for men.2Our results show that increasing
taxation (especially labour taxation) negatively leads both the labour force
and employment. Since the effect on employment is generally higher, in-
creasing taxation positively leads unemployment.
The analysis for growth components con®rms that taxation is negatively
associated with both the supply of and demand for labour. In this case,
however, the evidence that tax burdens are the crucial reason for explaining
differences in unemployment rate is weak.
The paper is organised as follows. In Section II we describe the method-
ology used for constructing the quarterly tax rates. In Section III we evaluate
1The correlation for countries for which both types of data are reported is .63 as can be calculated
from their Table 5.
2See OECD (1995) and Zee (1996).
174 Bulletin
#Blackwell Publishers 2001
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