"A tax on jobs" - experimental evidence

Does David Cameron know anything about the labour market of northern Finland? It seems not, judging from this:

If we put up National Insurance contributions on every job, employers will have to pay more for them. That’s bound to be a tax on jobs…Putting up the cost of employment will lead to fewer jobs being created and it will probably lead to jobs being lost.

But do NI contributions really affect jobs? This is where Finland comes in.
In 2003, the Finnish government wanted to boost employment in the northern part of the country. So it abolished some equivalents of our NI for firms in northern regions. This saved the average firm there around 4% of its wage bill.
Did this create jobs? The beauty of this plan was that it gave us a natural experiment. Because the tax cut only applied to firms in part of the country, it‘s possible to compare these to firms elsewhere in the country, to see if the lower “tax on jobs” created employment.
And it didn’t - at least not to any degree. This paper shows that “the payroll tax experiment has not had a significant effect on employment in the target region.“  It estimates that the average firm that got the tax break created less than one-tenth of a job as a result.
This experiment has been replicated elsewhere. Sweden has also tried regional variations in the equivalent of NI contributions, and has also found no great employment effects.
There are two reasons for this. First, wages rose in response to the lower payroll taxes, so the overall cost to many firms of employing labour did not fall as much as the tax fell. Secondly, the price-elasticity of demand for labour is low. Multiplying a low elasticity by a small cost change gives us a tiny number indeed.
My strong suspicion is that all this would also be true for the UK. We know from the effects of minimum wage laws that the price elasticity of demand for labour generally is low. And with capital powerful and labour weak, higher employer NICs are highly likely to be passed onto workers in the form of lower wages than they would otherwise get. The combined effect is that very few jobs would be destroyed.
And herein, I fear, lies the farce within the way this issue is debated by the two main parties. Cameron’s comments display an ignorance of both experimental evidence and the principles of tax incidence. And yet Labour cannot point this out, because to do so would be to draw attention to the fact that a rise in employers’ NICs would amount to, in all probability, a wage cut.
And some people wonder why we’re repelled by the election campaign.

Comments

[Luis Enrique]

v interesting. Could one legitimately raise the question of long-run versus short-run elasticities here?

[Econoclast]

I'm not sure which side is worse, as both seem utterly convinced the deficit will disappear once the efficiency 'savings' kick in. Perhaps we all need to stop fooling ourselves. There is no pain-free way out of this mess. The UK's relative living standards have got to fall. This debate is simply moving the deck chairs around.

[Recusant]

So a reduction in NICS would put more money into the worker's pockets? Sounds like a good result to me and a better fiscal stimulus than shaving 1.5% of VAT for 12 months. Labour does believe in fiscal stimuli, doesn't it?

[Mark]

Can we be certain that what was observed with a reduction in NI rates is the exact opposite to an increase?

Reducing NI rates does not of itself increase the amount of work to be performed in a firm. This may only happen if the firm lowers its prices, and as we see with exchange rate movements and exports often they prefer to maintain prices and earn a higher margin rather than lower prices to expand volume.

(So if NI rates are increased they may be unable to pass this on in the way of increased prices, and choose not to fill vacancies when they arise, so reducing the number of jobs in the economy).

I appreciate your argument is evidence based and so has this strength over mine. Just wonder whether can draw the conclusions you do with certainty.

[Owen Meredith]

Surely the difference is that in 2003, employment and economic growth was high already, so job creation wasn't top of the list.

In 2010, we have low growth and high unemployment. Both being linked. People looking to grow need/want to create jobs, a tax on those jobs makes it harder for them to do so. Added to the fact that a 1% extra tax on incomes forces down demand and risks a further cut in jobs as a result.

[tory boys never grow up]

Any economist worth their salt has always known that the income effects far outweigh the price effects when it comes to the labour market. But it is good never the less to have tested this little bit of Tory dogma - unfortunately most of main stream media and the bsuiness community do not understand this point.

If I were a rational business man, I would want a government that has a role in managing the overall level of demand in the economy. I see no tacit recognition of such a role by the Tories, and I have a horrible feeling that some of the key protagonists still believe in monetarism and the old crowing out hypotheses which were prevalant when they were being taught economics and starting their political careers.

[alanm crisps]

If the Tories actually believe NI is a tax on jobs, why don't they abolish it?

It is a rhetorical question. They are point scoring in an ideological vacuum of an election.

But I do wonder why the party whose USP is lower taxes don't ever seem to lower taxes.

[Gaw]

Well said - the election in a nutshell. It does all seem pretty picayune doesn't it? Meanwhile, all the politicians are carefully ignoring a number of large elephants cavorting around the room.

[Michael]

NIC increases clearly do add to the cost of labour - saying it has no impact on an unattractive area of the country for investment is no evidence at all. If NI was abolished in Merseyside, it is still unlikely that it would lose it's EU ESF Objective 1 status. Incidentally, Merseyside has had EU grants for years which have hardly turned the region into an economic hotspot. But jobs in Bootle may very well go to Poland or China if employment costs rise more in the UK.

[Steely_glint]

The thing with NI in this country is that it is non-linear. It is only paid on the first £20k (roughly) and more than half of it it is paid by employers (over and above salary). I doubt that the Finns have such a crazy system.
The effect of NI is that it is cheaper to pay overtime to your existing workforce than to hire in a few more people to add capacity. Thats why it has always been seen as a tax on jobs.
I don't think that logic applies in a recession, but it may when we are on the upswing and orderbooks fill up.

[Ralph Musgrave]

Neither the above article, nor any of the above comments seem to have spotted the glaringly obvious flaw in the “tax on jobs destroys jobs” argument, which is thus.

It is blindingly obvious that this tax, like all taxes, destroys jobs. But government spends the proceeds. Number of jobs created will approximately equal number destroyed! If government spends the proceeds on roads, schools and hospitals, then jobs are created in road construction, schools and hospitals.

Second, the above article rather confuses macro with micro. Altering an employment tax in just one part of a country is very much micro: i.e. if it has an effect, it could come via attracting work from other parts of the same country, which would be a micro economic effect. Thus this is not a good basis for judging the UK’s proposed NI increase which affects ALL employees in the UK and which is thus macro.

The laws of microeconomics normally don’t work at the macroeconomic level.

[Boursin]

I may be the only Finn regularly following this blog (a very sorrowful thought), so I might as well weigh in.

There are no earnings limits in Finland like there are in the UK. Currently, the employer contributes: 2.2% of the wage sum paid towards the health service; 16.9% towards pensions; and either 0.75% (on the first 1,846,500 euros annually) or 2.95% towards unemployment insurance. It was only the first of these three, the sickness insurance part, that was experimentally abolished in northern Finland.

The employees contribute from their wage packet: 2.4% for health; 4.7% for pensions; 0.4% for dole.

But the biggest difference to the UK is that these pension contributions go entirely towards earnings-related pension insurance, which it is mandatory for every employee to have, but which is administered entirely by private-sector entities - either an insurance company, a company pension fund or an industry-wide pension fund - on the basis of the contributions fixed at the above mentioned rates by statute.

The basic state pension, on the other hand, is financed entirely from ordinary tax revenues via the state budget and does not depend on the recipients' contribution history. (There used to be a small contribution of around 1% to 1.5% towards the state pension, paid entirely by the employer, but it was completely abolished recently as part of a stimulus package - it was already abolished in northern Finland as part of the experiment, explaining the 4% total saving reported by Chris.)

[Boursin]

So it might seem that we have even more of what was called above a "crazy system" - with a total NIC rate of 7.5% for employees and a whopping 19.85% to 22.05% for employers - but most of the latter goes to insurance companies, which immediately invest much of it back in the domestic private sector and are an important source of cheap credit for the very same enterprises that have to do the paying.

In part the tax helps create the very jobs it might at first glance be accused of destroying - but, unlike in the UK, it creates them exclusively in the private sector! This was the political price that had to be paid for getting the employers to consent to the system when it was enacted back in 1961, after a very complex and drawn-out political struggle between the various parties and interest groups.

[tory boys never grow up]

"Neither the above article, nor any of the above comments seem to have spotted the glaringly obvious flaw in the “tax on jobs destroys jobs” argument, which is thus."

Ralph I think I did - I just said it in a different way. Keynesians of the world unite!

[McGazz]

@Michael

"But jobs in Bootle may very well go to Poland or China if employment costs rise more in the UK."

I live in Bootle. There are no exportable jobs here. No matter how high labour costs get in the UK, no one here is going to go to Poland for their groceries or order a takeaway from China ;-)

[Pat Pending]

Cameron has not said a NI tax cut will directly lead to job creation.

He said don't increase National Insurance thereby preventing the NI increase leading to fewer jobs being kept i.e. not cut as well as companies being willing to create fewer jobs. This is not the same.

Anyway, when is a cut a not a cut? This tax does not exist yet so the money is not in the Government coffers yet. So, it does not exist to cut.

However, what does exist is Government expenditure that Brown's Government wants to continue increasing whilst having to be seen to try to reduce the national debt and borrowing to fund it.

The NI increase is essential for Brown to keep spending. If the NI increase is not introduced it has the knock on effect that all of the public employees (teachers, civil servants, etc.) will be contributing less tax as NI.

The Government wants that tax. Of course, it has to fund the education, health service, Government departments, etc., to pay this NI and has to borrow to pay it to themselves (yes, go figure that one)

[js]

there is plenty of research on public sector crowding out the private sector, and the trade-off between the two. There is plenty of research on the long term growth of high tax vs medium tax countries, and thus rate of increase in living standards. There has to be a balance, and whilst it perhaps once went too far the other way, it is now too far the other.

[TAX JOBS]

and the trade-off between the two. There is plenty of research on the long term growth of high tax vs medium tax countries, and thus rate of increase in living standards. There has to be a balance, and whilst it perhaps once went too far the other way, it is now too far the other.