APPENDIX I The Profit-Maximizing Enterprise: Comparison of Wages and Employment Without and With EWT With Two Types of (Skilled and Unskilled) Labor
The proof presented here serves to generalize the heterogeneous labor model in Section II.4. In that section, we assumed that α = 1 hence n2 may not be paid a wage less than
As explained in Section II.2, using (43) and (44), we can show that the (effective) marginal cost of n1 with EWT is unambiguously greater than the marginal cost without EWT since
We are interested in the impact of the increase in the marginal cost of n1 under EWT on the amount of both types of labor employed by the firm, hence on the wages paid; that is, we wish to compare (n1*,w1*) and (n2*,w2*) with (n1,w1) and (n2,w2).
The first and second-order conditions which follow from (43) are 40/
Totally differentiating the first-order conditions in (46) and making the relevant substitutions, we can show that
Therefore, dw1/dw2 > 0 and dw2/dw1 > 0, provided that f12 > 0 and n1’, n2’, >0. Since it is also clear from (46) that dg1 = g1’dw1 and dg2 = g2’ dw2, it follows that dg1/dg2 > 0. 41/
Further, totally differentiating the first-order conditions in (46), we can show that
Since dg1/dg2 > 0, the signs of dn1/dg1 and dn2/dg1 would be negative provided that
The foregoing conditions correspond to the first and second-order conditions in the perfectly competitive labor market case.42/ While these conditions are neither sufficient nor necessary for profit maximization under monopsony, they are adequately general. They indicate that with decreasing marginal product for both types of labor and f12 > 0, dn1/dg1 < 0 and dn2/dg1 < 0 under monopsony.
Therefore, under adequately general assumptions for the production function, it follows that, since
The foregoing results can be easily extended to the case discussed in Section II.4 with α = 1,
Thus, under an adequately general set of assumptions, when n1 and n2 are interpreted to be the managers and workers, we can conclude that the incidence of EWT is on both the managers and the workers. Under EWT, the profit-maximizing enterprise does not surround a few high-wage employees with many low-wage employees in order to reduce the tax burden. 44/ With heterogeneous labor, irrespective of whether some classes of labor are paid wages below the norm
Appendix II Behavior of w and w* with respect to
From (7), the first and second order conditions for maximum profit without EWT can be found respectively as
However, from (8), the first and second order conditions for maximum profit with EWT can be found respectively as
Differentiating (52) with respect to
For a sufficiently high minimum wage,
Appendix III Self-seeking managers: comparison of the managers’ wages without and with EWT
From (37) and (38), the managers’ share without and with EWT can be shown as, respectively,
Since n1 is assumed to be the same in both cases, w*1 < w1 if w*1n1 < w1n1. From (56), w*1n1 can be expressed as
Also notice from (56) that, for
which indicates that the second term on the right-hand-side of (57) is negative. Since w*2 < w2, it is clear from (55) and (58) that
because the value of w2 for which (55) is maximum is different from the value of w2 for which (56) is maximum. Therefore, in view of (58) and (59), w*1n1 < w1n1 hence w*1 < w1.
Appendix IV REPUBLIC OF BULGARIA Council of Ministers Decree No.28 of 9 February 1994 on Adopting the Regulations on the Increment and Formation of Wage Funds in 1994
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Mr. Tait is Special Trade Representative and Director, Office in Geneva, and Mr. Erbas is an Economist in the Middle East Department. The views expressed in this paper are the personal views of the authors and do not reflect the official position of the International Monetary Fund. The authors wish to thank Sheetal Chand, Prof. Gerald Dwyer, James Gordon, Daniel Hewitt, Zubair Iqbal, Malcolm Knight, Chera Sayers, Victor Thuronyi, Jean-Philippe Vincent, an anonymous referee, and the participants of a seminar at the Department of Economics, Clemson University, for their input and helpful comments. The authors are responsible for any remaining errors. This paper will be published in a forthcoming collection of studies on the macroeconomic aspects of public finance, edited by Teresa Ter-Minassian and Mario Blejer.
In this example, the minimum wage may also be viewed as the norm against which “excessive” wage awards are compared, triggering the EWT. Thus, the inflation adjustment of the minimum wage would correspond to the Inflation adjustment of the norm. The choice of a one-month tax period for the purposes of this example is arbitrary; in reality, the relevant period is the statutory tax period.
For example, in Russia such revenue amounted to about 5.0 percent of budget revenue in 1993/94 (or 30 percent of the corporate tax yield). In contrast, in Kyrgyzstan revenue from EWT made up less than 2 percent of enterprise profits tax revenue in 1991.
This arrangement would be similar to wage indexation; see, Gray (1976). For a discussion of profit-sharing arrangements and their macroeconomic impact, see Weitzman (1984, 1985); on the same subject, also see Nordhaus (1988) and Weitzman’s (1988) rejoinder.
The state-owned enterprise may totally or partially transfer the returns to capital to the government. In this case, if EWT affects profit, total government receipts (the government’s share of profits plus taxes) are also affected.
For simplicity, the minimum wage can be viewed as the norm or inflation adjusted average wage, as determined by the government.
Modeling a progressive corporate income tax (Azerbaijan, Kazakhstan, Moldova) or progressive taxation of the excess wage bill (Poland, Estonia, Latvia) would not affect the general analytical results below.
The heterogeneous labor case which allows for a distinction between managers and workers is discussed below; for the case of α > 1, see appendix I.
We shall not attempt to compare the monopsony case to the competitive labor market case since it is well-known that the equilibrium with monopsony is inferior to that which obtains with a competitive labor market. However, the main conclusions that are derived for the monopsony case can be readily extended to the competitive labor market case.
Comparing g and g* at the same values for the wage rate, we can show that g < g* if
That is, (1-r)[f(n) - wn], evaluated at w*, Is smaller in value than when it is evaluated at w; hence (1-r)[f(n*) - w*n*] < (1-r)[f(n) - wn] and π*max < πmax. The same result holds with competitive labor market as can be seen by comparing π*max and πmax at the same wage rate,
As shown above, the effectiveness of EWT depends on fn and θ. Given those parameters, if EWT is effective then w* does not exceed the minimum wage by a wide margin; then, as indicated by (21), EWT revenue is lower. Therefore, it may be argued that the more effective EWT the lower the revenue from EWT.
The opposite results would hold if the rate of increase in the nominal minimum wage exceeded the rate of inflation. Here, we focus on the policy aim of containing “excessive” wage awards by the enterprise in the face of inflation.
Similar arguments are valid in the case of the competitive labor market. As shown in Section I.1.a, in that case, although EWT does not affect the wage level, it affects the firms’s output-employment level. Thus, if the minimum wage declines, then, as indicated by (10), marginal cost rises, which implies a lower aggregate output-employment level.
We define a formal analysis of inflationary adjustment over time in response to the government’s minimum wage policy under EWT as outside the scope of this paper.
Thus, Y - V(M/P) is assumed to represent the aggregate demand function.
For the stability of the new path of the price level, we may assume that at the time when the price level jumps upward, the government adjusts the nominal minimum wage so as to keep the real minimum wage at its initial level. The lack of such adjustment, as it is likely to present itself in reality, implies interesting inflationary dynamics under EWT. If the nominal minimum wage is not adjusted in response to the jump in the price level, then the real minimum wage declines which sets in motion a further decline In the equilibrium real wage, hence a decline in output, hence a further jump in the price level.
In this paper, we do not attempt to provide a comparative analysis of the effects of EWT on the competitive enterprise versus the labor-dominated enterprise and limit the analysis in this section to the impact of EWT on the labor-dominated enterprise. Nevertheless, such a comparative analysis would be illuminating in explaining the aggregate wage and employment behavior in the former socialist countries during structural transition from a system characterized by labor-dominated enterprises to a system characterized by competitive privatized enterprises; a study related to this issue is by Stewart (1984).
In the FSU, the common practice for the enterprises is to make significant contributions toward such benefits.
We can show that
In this case, since output level is not affected by EWT and r is given, the increase in the tax base would unambiguously lead to an increase in tax revenue with EWT. To the extent the increase in revenue results in a lower recourse to inflationary finance, the rate of money creation may decline hence the inflation rate may decline.
This phenomenon has been observed in most transition economies.
Arguably, the government is not likely to have enough information to choose πg = πmax or πg = π*max therefore, similar to the first case discussed above, the enterprise has the leeway to negotiate the level of profit transfer to the government.
Both ∂w1/∂2 and ∂w*1/Ƞ2w2 are negative.
See appendix III. Akin to the result in the case of profit maximizing enterprise in (19), the “profit” or the rent reaped by the managers through maximizing their own wages is lower with EWT.
In this case, since n1 is constant, lower n2would generally imply a lower output level, therefore, given constant money supply and velocity, price level would jump when EWT is imposed.
This point invokes a question which is similar to the familiar one that may be posed in market economies: would the tax authority allow the enterprise to declare losses by making excessive wage payments to the managers or to shareholders who are disguised as workers? At least in the case of the United States, the Internal Revenue Service’s answer is patently no. In the case of FSU and Eastern European countries, the existing EWT legislation does not address the question.
This went by the delightful name of the “POPIWEK” or PPWW.
In 1990, the excess of actual wages above the norm toward the end of the year has been partly attributed to consuming the unutilized margin between the actual wages and the norm from the first half of the year, which could be carried out without triggering PPWW; see Pinto (1992b), p.107, and, Figures 2-6, pp. 118-122.
For evidence on wage and output-employment developments in 1990, see Pinto (1992b) in Coricelli and Revenga (1992); the inflation adjustment of the wage norm (minimum wage in our model) being only partial (the inflation adjustment coefficient was typically less than unity), from December 1990 to March 1991, the real wage norm and actual real wages declined (Table 4, p.107). For further evidence on the negative impact of PPWW on wages, see Pinto and van Wijnbergen (1994).
A shipyard paying about 30 percent above the average wage, in arrears on PPWW, received a one-third reduction of debts (including accounts payable). Mining companies also were exempted.
In fact, further shuffling to and fro occurred. The “Popiwek” lapsed as of March 31, 1994 but a further revised version re-emerged in August 1, 1994 (Schwartz, 1994, p. 21).
This exemplifies a problem in many reforming socialist economies regarding the ownership of capital. Since capital used to be allocated through the plan, enterprise mangers had little obligation or incentive to pay a return on capital; instead managers paid as much of enterprise revenue as they could in wages or in other forms of compensation to labor.
This extremely controversial tax applied to wages and profits, was suspended in September of the year it was introduced, forgiven for the first two quarterly payments, reintroduced in 1976 but not applied, introduced again in 1977, and again not applied, and finally, like the Cheshire cats’ grin, faded from view forever; see de Wulf (1986) and Chand (1981, 1986) for descriptions. This emphasizes the difficulty, experienced in most countries reviewed in this paper, of administering this tax in the face of intransigent non-compliance.
he authors are grateful to the participants of a seminar at the Department of Economics, Clemson University, for pointing out this possibility, which had been omitted in the previous version of the paper.
Notice from (44) that, trivially, EWT does not apply in the reverse, that is, the enterprise does not receive a subsidy for paying
Notice that (44) can be written as
As in (13), we can show that f1 = g1 = (1+θ1)w1/θ1 and f2 = g2 = (1+θ2)w2/θ2. If θ1 and θ2 are constant, as assumed, we have dg1/dg2 = γ(dw1/dw2)>0, where γ=[(1+θ1)θ1]/[(1+θ2)θ2]>0.
Notice that in the competitive labor market case, the first-order conditions are f1=g1(w1)=w1 and f2=g2(w2)=w2 where w1 and w2 are constants.
Further notice that the model in Section II.4 is useful in determining the impact of EWT on the level of capital employed by the firm. In that model, if we treat n2 as capital, k, and assume that the rental on capital is given as r, by substituting k for n2 and r for