Workers in Countries with High Taxes Provide Less Labor

The Biden administration’s social spending plans are not fully articulated, but constitute a major addition to the $2.2 trillion Covid-19 pandemic relief package supported by the Trump administration a year ago.  The American Rescue Plan passed win March 2021 has already added $1.9 trillion to that total.  It provided relief funds for states, local governments, tribes and US territories.  It also provided helicopter cash to individual Americans, enlarged unemployment insurance benefits and enlarged federal housing subsidies. 

A second and third plan are in the wings waiting to be fully articulated.  The second is the American Jobs Plan, focused on a very generously-defined concept of infrastructure spending.  This plan has an estimated price tag of $2.3 trillion.  Biden has rejected the use of user charges to finance even the genuine, infrastructure projects. At the moment, his aim is to finance this catch-all program with through increased taxation of domestic and multi-national corporations.  

The third plan is the American Families Plan, with an estimated price tag of $1.8 trillion.  One trillion is direct spending and the rest likely will take the form of targeted tax credits and enlargement of the IRS.  The list of programs supported by this plan is huge, including subsidized child care, medical and family leave programs. health insurance assistance, free universal pre-school, free community college education to immigrants as well as citizens.  These would be paid for by redistributive tax levies on those with high incomes and capital gains.  

The Biden plans thus represent an increase in spending of $6 trillion   A long literature on taxes and labor supply suggests that there will be a reaction of workers to any tax levies needed to fund these plans.  However, these studies do not roll up the impact of higher taxes to the national level.  

The purpose of this post is to present an examination of the impact of higher taxes nationwide.  It uses a cross section of national data developed by the Organization for Economic Cooperation and Development (OECD).  The OECD membership is comprised of most of the major, western countries.  We use OECD data in this study to measure the national impact of increased taxation.  

Specifically, the OECD periodically measures the tax burden on the typical worker by constructing the so-called Tax Wedge—the percentage of the typical worker’s income that is usurped by government levies.  The OECD measure is based on the percentage tax exposure of a household comprised of a single individual, without children, at the income level of the average worker.  In 2011, the tax wedge ranged from 7 to 55 percent across the 33 countries for whom data is available.  

The microeconomic theory of policy impacts on individual workers postulates that the worker will withhold supplying labor services if taxed on these services. The graphic below plots, by the size of the tax wedge, the annual average number of hours that the workers will spend working.  The data used is the 2011 tax wedge and the 2018 labor hours supplied, by country. 

Figure 1.  Taxes Reduce Workers' Willingess to Supply Labor

The choice of 2018 for the work-hours data is not critical.  In general, tax policy evolves sufficiently slowly that all we need is data that is later than the year in which the tax wedge is measured.  Use of earlier years does not change the findings.  There is considerable variability in the data.  However, as the figure reveals, in general, the higher the tax wedge, the lower is the number of hours that workers offer the economy.  The experience of countries with large spending programs is that the ultimate incidence of the tax burden ends up being borne significantly by the average worker.  

The countries with the largest tax wedges tend to be European social-democratic countries.  Across all of the countries, the average annual hours worked varies dramatically.  The US worker, at 1800 hours per year, works  approximately 30 percent more that workers in the most highly taxed countries.  Statistically, for a given percentage increase in the tax wedge, hours worked decline by 20 percent of of that increase.