We show that the cross country variation in the level of social security taxes explains the variation in the level of underground or 'secondary' labor market activities. We then perform policy experiments where we vary the level of this taxes, shifting most of the burden from workers to firms and vice-versa. We find that it is optimal to make firms take on more of the "labor income tax" wedge - both in terms of welfare and fiscal revenue.

1. Striking a Balance:
Optimal Tax Policy with Labor Market Duality
Gilbert Mbara,
with
Joanna Tyrowicz & Ryszard Kokoszczynski
University of Warsaw
73rd Annual IIPF Conference ,
Tokyo
August 19, 2017
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2. Remarkable dispersion in how labor is taxed and
benefits financed
Figure: Labor taxes and social security contributions in the OECD
Data: OECD, 2014, SINK at 100% of average
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3. Implications of this dispersion
Figure: “Evasion” of Employer Component of Social Security Contributions
in the OECD
Data: OECD, 2004, Receipts to Theoretical Liability Ratio.
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4. Gaps in the Literature
Why is there such dispersion across countries?
What are the implications of such a dispersion?
No evaluation in the literature.
Literature focuses on:
Measuring unregistered employment (predominantly Schneider 2014),
mostly about Latin America, Italy and (some) Germany. Busato and
Chiarini (2013), Orsi et al. (2014) mostly Italy (good data on
unregistered work)
Optimal tax rates: Trabandt and Uhlig (2011) get an “optimal” tax
rate without evasion
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5. Our Contributions
Dispersion can explain (cross-country variation of):
Tax Evasion (of Employer Social Security Contributions) – linked to,
Unregistered employment
We provide:
=⇒ plausible microfoundations for secondary employment (+
estimates of size)
=⇒ Optimal tax policy: fiscal and welfare evaluation
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6. Road map
Model
Calibration
Results
Conclusions
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7. Key elements
Two types of labor taxes:
Unavoidable τn
paid by workers (labor income tax)
Avoidable τs
paid by employers (employer SS contributions)
Labor may be hired with a:
typical contract, employer pays τs
> 0 (P=primary worker)
atypical contract, employer sets τs
= 0 (S=secondary worker)
◦ ≡ tax evasion.
Both types of labor identical in terms of productivity
Households have preference over types of contracts
Government is not strategic about taxes
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8. The model - firms
Many firms, need both capital and labor
y =Akα
n1−α
, where
n = (1 − ω)nρ
P + ωnρ
S
1
ρ
σ =
1
1 − ρ
and ω =
nS
n
Hiring labor atypically exposes to risk of fine for tax evasion
πe
= pπD
+ (1 − p)πND
= y − dk − (1 + τs
)wPnP − (1 + p¯sτs
)wSnS
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9. The model - households
Representative household with labor endowment
No auditing of households (no tax evasion on labor income tax)
U(c, l(nP, nS)) =
1
1 − η
c1−η
(1 − κ(1 − η)(nP + φnS)
1+ 1
ϕ )η
− 1
With the following budget constraint
(1 + τc
)c + b + x =
(1 − τn
)wPnP + (1 − τn
)wSnS ⇐ labor income
+πe
+ (1 − τk
)(d − δ)k + δk ⇐ capital income
+Rb
b−1 + s + m ⇐ bond interest, etc.
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10. Calibration I: Standard parameters
Table: Calibration of model parameters
Parameter Value Source
α Capital share in output Country Specific EC
ψ TFP growth 1.017 EC
¯R Gross interest rate 1.04 Standard
η Inverse of IES 2 Standard
ϕ Frisch’s elasticity 1 Standard
τc , τn, τk Consumption, Labor, Capital Tax Country Specific OECD
τs Employer Social Security Tax Country Specific OECD
b Public debt (in % of GDP) Country-specific OECD
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11. Calibration II: Four difficult parameters
p¯s – expected penalty for tax evasion.
ω – weight of atypically employed labor: ns in n
ρ – elasticity of substitution between the two types of labor.
Imposing ω = nS
n
in n = ((1 − ω)nρ
P + ωnρ
S )
1
ρ =⇒
1 = (1 − ω)1+ρ
+ ω1+ρ
FSS = τs
wP nP + p¯sτs
wS nS = (1 − α)
τs
(1 − ω)1+ρ
1 + τs
+
τs
p¯sω1+ρ
1 + p¯sτs
LTR = τn
(wP nP + wS nS ) = (1 − α)τn (1 − ω)1+ρ
1 + τs
+
ω1+ρ
1 + p¯sτs
φ – disutility of atypical contract
1
φ
=
wp
ws
=
1 − ω
ω
ρ
1 + p¯sτs
1 + τs
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12. Model fits data (fairly) well
Share of output due to secondary workers/labor: yS = (1−α)ω1+ρ
1+p¯sτs
Figure: Model Predicted Size of Informal economy vs. Schneider (2014)
Pearson’s r at 0.6419 (p-value=0.0073).
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13. Firms Social Security Contributions vs. ω
Figure: Model predicted ω vs tax structure
Pearson’s r at 0.4553 (p-value= 0.0764).
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14. Optimal Tax Policy: Static
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15. Labor Tax Laffer Curve
Figure: The shape of Laffer curves
0 0.2 0.4 0.6 0.8 1
Tax Rate: τs
+ τn
0.06
0.08
0.10
0.12
0.14
0.16
0.18
0.20
0.22
0.24
TaxRevenues
EU-14
Evasion
No Evasion
Data
0 0.2 0.4 0.6 0.8 1
Tax Rate: τs
+ τn
0.06
0.08
0.10
0.12
0.14
0.16
0.18
0.20
0.22
0.24
TaxRevenues
USA
Evasion
No Evasion
Data
Tax revenue = overall tax revenue T. Ratio of τs
to τn
fixed at Steady State.
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16. Policy Mix: Revenue, Employment and Welfare
(a) Fiscal revenues
TaxRevenues
(b) Employment and Welfare
Solid lines: T [(a)] and ω [(b)] with φ fixed at steady state level. Dotted–dashed
lines: φ changing based on ω and τs
. Circle: steady state share of τs
in labor income
taxes and corresponding tax revenue.
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17. Optimal Tax Policy: Dynamic
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18. Two thought experiments: EU baseline: 37% share of
τs
; ω=16%; φ=1.07
Scenario 1 (DNK): 0.0% share of τs; ˆω=12%; ˆφ=0.98
Scenario 2 (FRA): 50% share of τs; ˆω=28%; ˆφ=1.10
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19. Changing the mix of avoidable and unavoidable
Figure: Policy experiments in tax mix for EU-14: transition paths
Responses to a change in the ratio of taxes: from τs = 0.147 to τs = 0.0 (black line -
Policy 1: DNK) and to 0.204 (blue line - Policy 2: FRA), τn adjusts accordingly.
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20. Conclusion: Welfare Effects across Countries
Equivalent units: λ = 1 −
1 + (1 − β)(1 − η)Welfarebaseline
1 + (1 − β)(1 − η)Welfarereform
1
η−1
Bars: welfare changes in λ at the end of transition to new steady state.
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21. References
Busato, F. and Chiarini, B.: 2013, Steady State Laffer Curve with the
Underground Economy, Public Finance Review pp. 109–114.
Orsi, R., Raggi, D. and Turino, F.: 2014, Size, Trend, and Policy Implications of
the Underground Economy, Review of Economic Dynamics 17(3), 417–436.
Schneider, F.: 2014, The shadow economy and shadow labor force: A survey of
recent developments, IZA Discussion Paper 8278, Institute for the Study of
Labor (IZA).
Trabandt, M. and Uhlig, H.: 2011, The Laffer curve revisited, Journal of Monetary
Economics 58(4), 305–327.
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