Taxes and work

Working-age Belgians, French, and Germans spend, on average, about 1,000 hours a year in paid work. In the United States, Switzerland, and New Zealand, by contrast, the average is around 1,300. This is a pretty big difference.

These averages are determined by the share that have a paying job and the number of hours worked over the course of a year by those with a job. In the United States, for instance, the employment rate in 2007 was 72% and those employed worked an average of 1,800 hours (.72 x 1,800 = 1,296). In France, the employment rate was 64% and the average number of hours worked by those with a job was 1,550.

In a paper published in 2004, Edward Prescott concluded that taxes are the principal cause of the cross-country variation in working time. Prescott’s conclusion was based on the association between tax levels and work hours in the early 1970s and the mid-1990s in Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

The hypothesis is sensible. Taxes reduce the (direct) financial reward to paid work. This encourages people not to work at all or to work fewer hours.

But how large is the effect? After all, some people will work more when taxes are higher, in order to reach their desired after-tax income. More important, lots of other things affect people’s calculations about whether and how much to work, including wage levels, employment and working time regulations, paid vacation time and holidays, availability and generosity of government income transfers, access to health insurance and retirement benefits, the cost of services such as child care, and preferences for work versus leisure. A good recent study of work hours among those who have a job concludes that taxes seem to have an effect for women but not for men, and that taxes account for a limited portion of the cross-country variation. In own my research (here and here), I’ve found pretty strong indication that the tax mix matters; heavy reliance on payroll taxes is associated with slower increase in the employment rate over the past three decades. But that doesn’t necessarily tell us anything about the impact of overall tax levels.

Here is the association between annual work hours per working-age person in 2007 (before the crash) and tax revenues as a share of GDP over the years 1979 to 2007. The pattern looks supportive of the notion that high taxes reduce work hours.

But knowledgeable comparativists will notice a familiar clustering of countries. Here’s the same chart with three groups highlighted.

One group, in the lower-right corner, includes Germany, Italy, the Netherlands, France, and Belgium. These countries, along with Austria, have several features that might contribute to low work hours. One is strong unions. Organized labor has been the principal force pushing for a shorter work week, more holiday and vacation time, and earlier retirement. These nations also have been characterized by a preference for traditional family roles: breadwinner husband, homemaker wife. This preference, often associated with Catholicism and “Christian Democratic” political parties, is likely to influence women’s employment and work hours. It is manifested in lengthy paid maternity leaves, lack of government support for child care, income tax structures that discourage second earners within households, and practices such as German school days ending at lunch time and French schools being closed on Wednesday afternoons. These countries also fund their social insurance programs via heavy payroll taxes, the kind most likely to discourage employment growth.

A second group consists of the four Nordic nations: Denmark, Sweden, Finland, and Norway. These countries too have strong unions. But they also have had electorally successful social democratic parties, which have tended to promote high employment. Denmark and Sweden, in particular, have been at the forefront in use of active labor market programs to help get young or displaced persons into jobs, public employment to fill gaps in the private labor market, and government support for child care and preschool to facilitate women’s employment.

A third group of countries, in the upper-left corner, includes the United States, Japan, Australia, New Zealand, and Canada. These nations have relatively weak labor movements and limited influence of social democratic parties and Catholic traditional-family orientations.

The other five countries — Ireland, Portugal, Spain, Switzerland, and the United Kingdom — are a hodgepodge. (Some would include Ireland and the U.K. in the “weak labor” group and Spain and Portugal in the “traditional family roles” group. Doing so doesn’t alter the conclusion here.)

Based on their institutional-political makeup, we would expect the weak-labor countries to have comparatively high work hours, the social democratic countries to be intermediate, and the traditional-family-roles countries to have low hours. As the following chart indicates, that’s exactly what we observe.

So is it really heavy taxation that produces comparatively low work hours? Or is it strong unions and preferences for traditional family roles? If we adjust for institutional-political group membership, the negative association between tax levels and work hours disappears.

Given that the institutional-political groupings account for much of the cross-country variation in levels of work, we might be better able to detect the true impact of taxes by examining changes. The following chart shows change in work hours from 1989 to 2007 by change in taxation from the 1980s to the 2000s. There is no association to speak of; the regression line is negatively sloped, but it is nearly flat and the countries are widely dispersed around it. Perhaps most revealing is the pattern among the twelve countries bunched around zero on the horizontal axis; despite little or no change in tax levels over this period, these nations varied sharply in the degree to which average work hours changed.

Is it levels of taxation, rather than changes, that cause changes in work hours? No; here too we find no association.

While heavy taxation surely creates some work disincentives, the overall tax level doesn’t seem to be an important determinant of differences in employment hours across the world’s rich countries.

7 thoughts on “Taxes and work

  1. Interesting.

    But I think there is clearly another discrete group in the 2nd chart, Portugal, Ireland, Spain. These too are defined by the predominance of Christian Democratic parties or values and relatively female participation in the workforce. They also have reasonably high union densities. However, this has been expressed not in greater rights or shorter hours, or even higher pay.

    Various forms of a tripartite ‘social partnership’ involving govt., unions and employers, have led to the trade-off of wage moderation for lower taxes, hence the low proportion of taxation. But, with ex-ante low female and/or youth participation in the labour force and weak infrastructure, the low taxation model has not allowed the investment that would lead to restoring the twin jobs and infrastructure deficits.

  2. This stands in interesting contrast to the old Single-Tax proposals of taxing ‘land’ only, and not wages or capital.

  3. A greater preference for leisure seems a more sensible explanation. Culture, not taxes, set those things. Look at your own life.

  4. Aren’t strong unions highly correlated with regressive taxation of labor?

  5. The 127 citations for the 2004 Prescott paper at IDEAS suggests that the literature might have moved on a bit since then using wider settings for modelling.

    Richard Rogerson took up the challenge laid down by Prescott as did Thomas Sargent and Lee Ohanian and many others.

    The work on the different levels of household production across the Atlantic and the failure of the EU to develop a services sector is of particular interest.

    References to an increased preference for leisure in Europe are courageous rear-guard actions.

    In the late 1970s, Modigliani dismissed the 1969 Lucas-Rapping paper on the U.S. great depression as the great vacation theory of depressions where the voluntary unemployment of the 1930s is explained, in Modigliani words, as a congenital attack of laziness.

    An increased preference for leisure is another name for voluntary unemployment.

    As Prescott pointed out in papers in 2002, 2004 and 1999, the USA in the Great Depression and France since the 1970s were both 30% drops in hours worked per adult. That is why Prescott refers to France’s economy as depressed.

    An unusual left-right unity ticket has emerged to explain depressions in the 1930s and after the 1970s: the great vacation theory.

  6. Hi, I am probably a little late to the party, but an argument can be made that the tax system is shaped and may be even shaping family structures. The joint tax assessment of married couples in Germany is a well-known example in stabilising male breadwinner income.

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