Payroll taxes collect about 25 percent of total tax revenue in OECD countries, about as much as revenue from personal income taxes. In recent decades, cuts to the employer portion of payroll taxes are often discussed as a policy lever to reduce labor costs of firms, particularly targeted towards workers facing high unemployment rates such as low earners, the elderly, or the young. A potential drawback of employer payroll tax cuts is that firms instead pocket the tax cut as profit windfall.
In contrast, academic economists hold the received wisdom that the incidence of payroll taxes ultimately falls on workers’ net wages. A payroll tax cut thus leaves firms’ gross labor costs – and employment – unchanged according to this view.
This report sheds light on this debate by examining the payroll tax cuts for young workers in Sweden that were implemented in 2007 and in 2009. These reforms halved the payroll tax for workers aged 26 and below.
The policy was proposed as a way to stimulate both employment among the young and business activity. It was criticized by opponents – who ultimately repealed the tax cut in 2015 when elected – as a costly give-away to employers. Our results suggest that targeted employer payroll tax rates may be an effective tool to stimulate youth employment with. Moreover, the windfall gains to firms that the policy induced were actually used constructively, lending support to the former view of the effectiveness of targeted payroll tax cuts.
The report was presented at an SNS seminar in Stockholm on May 15, 2019.
David Seim, Associate Professor of Economics, Stockholm University.
*This is a summary of a research brief in Swedish “Sänkta arbetsgivaravgifter för unga”, which is a publication within the SNS research project “Taxes in a Globalised World”.