Effects of Changes in Payroll Taxes – Theory and U.S./Swedish Experiences

This paper includes theoretical and empirical analyses of some effects of changes in payroll taxes. First, the implication of the standard partial equilibrium analysis is explored in Section II. In particular, the relationship between statutory and economic incidence are clarified and the textbook neutrality conventionally taken for granted is shown to be subject to strong qualifications. It is demonstrated that the wage and employment effects of a one percentage point increase in the employers contribution generally will differ from the effects of an increase by one percentage point of the employees ' tax rate. Given the institutional features of the U.S. income and payroll tax systems, the theoretical results imply that a given increase in the employees' payroll tax rate will induce greater employment reductions (and greater increases in wage costs) than an increase in the employers part of the tax. This non-neutrality, however, does not prevail when the incidence of incremental payroll tax changes is analyzed; labor's net income loss per tax dollar is exactly the same in the two policy alternatives.