Tax mixes, welfare states and employment: tracking diverging vulnerabilities

Abstract

Contemporaneous welfare states use different mixes of income, payroll and indirect taxes to fund expenditures. The paper investigates how this mix affects the labour market. It briefly discusses the evolution of tax mixes over time and countries before dealing with three claims in more detail. First, countries with high levels of payroll taxation are expected to exhibit a worse aggregate labour market performance than countries relying on income taxation. Second, this finding should hold for low-skilled sectors in particular. Third, since all countries have opened up their goods and capital markets, the impact of taxation on labour market outcomes should have increased over time. These claims are empirically evaluated by a cautious, step-by-step analysis of cross-country and temporal variation in the tax mix for eighteen OECD countries. Whereas the evidence for the first two claims is substantial, evidence on internationalization remains inconclusive. The results help to explain why welfare states show diverging forms of vulnerabilities for employed people.