1. The model

This model assumes that profit maximization motive dominates corporate behavior. This assumption may not be very suitable to examine the behavior of SOEs in the transition economies. Nevertheless, it provides a framework for a first-order analysis of the impact of EWT and is pertinent due to the ongoing reform efforts to restructure and privatize SOEs in the process of transition to a competitive market system in which the profit motive is dominant.

Let us assume that the representative enterprise employs l types of labor, n_i, i=1, 2, ..., l, and each type of labor is paid the nominal wage, W_i. Further assume that capital, k, is homogeneous, the return to capital accrues to the enterprise ^6/, and the enterprise produces a single good which it sells in a competitive market at price p. Let the production function be

The total (real) wage bill of the enterprise can be expressed as

where w_i = W_i/p. Assuming that the corporate income tax is levied at a single rate, 0 < r < 1, the enterprise profit, π is

_ Suppose the economy-wide minimum wage is determined by the government at $\overline{W}$^7/ Hypothetically, if all types of labor were paid the minimum wage, the enterprise’s total wage bill would be

where $\overline{w}=\overline{W}/P$. EWT is triggered if the total wage bill, as expressed in (2), exceeds a predetermined multiple, α ≥ 1, of the hypothetical wage bill calculated at the minimum wage, as expressed in (4). Therefore, the EWT base is

to be taxed at the standard corporate income tax rate, r. ^8/ Then, the enterprise after-tax profit with EWT, π* is

The analysis can be simplified if we assume k is constant, labor is homogeneous (l = 1), and α = 1. ^9/ Under these assumptions, (3) and (6) simplify to, respectively,

where k is suppressed.

2. The incidence of EWT

Let us first examine the case where θ = 0 or labor supply is perfectly inelastic. In this case, (13) and (14) imply that b = b* = 0 since b, b* ≥ 0 by assumption; hence $w=w*=\overline{w}$, that is, the monopsonist enterprise pays the lowest wage possible. Therefore, π = π* and the equilibrium wage and employment levels are not affected by EWT.

To examine the intermediate case when 0 < θ < ∞, let us first note from (7) that the total (effective) cost of production without EWT is C =(1-r)wn; hence the marginal cost is

Similarly, (8) indicates that the total (effective) cost of production with EWT is $C*=(w-r\overline{w})n;$ hence the marginal cost is

Comparison of g and g* shows that, as in the competitive labor market case,

for all $w>\overline{w}$. The enterprise maximizes profit by equating marginal cost to marginal revenue. Notice that, with or without EWT, the net marginal product is plotted by (1-r)f_nn’ for all $w\ge \overline{w}$. Therefore, in equilibrium,

where n* is the equilibrium level of employment with EWT corresponding to w* and n is the equilibrium level of employment corresponding to w ^11/. Hence the output level with EWT is less than the output level without EWT.

As regards the profit level, comparison of (7) and (8) in equilibrium shows that maximum profit with EWT, π*_max, is less than maximum profit without EWT, π_max, that is,

unambiguously; (19) holds since w > w* or the wage level at which (7) is maximized is not the same as w*. ^12/

It may also be noted that EWT penalizes more productive enterprises. From (13), we can show that, without EWT, for the enterprise to pay $w>\overline{w}$, the marginal product of labor needs to be such that $f_n>\overline{w}\frac{(1+\theta )}{\theta }$. But with EWT, for $w*>\overline{w}$, (14) indicates that it is necessary to have $f_n>\overline{w}\frac{1+\theta (1-r)}{\theta (1-r)}$, and, for constant $\theta ,\frac{1+\theta (1-r)}{\theta (1-r)}>\frac{1+\theta }{\theta }$.

First suppose the enterprise’s (labor) productivity without EWT is such that it pays the minimum wage; then, the enterprise is unaffected by the imposition of EWT. Now suppose that the enterprise productivity without EWT is such that $\frac{1+\theta }{\theta }<f_n<\overline{w}\frac{1+\theta (1-r)}{\theta (1-r)}$ then, with EWT, the enterprise pays the minimum wage. Only if the enterprise productivity is high enough such that $f_n>\overline{w}\frac{1+\theta (1-r)}{\theta (1-r)}$ it is profitable for the enterprise to pay a wage exceeding the minimum and bear the burden of EWT. It follows that the more productive enterprises are the ones to pay wages exceeding the minimum wage under EWT.

To recapitulate, the incidence of EWT is both on labor and the enterprise; with EWT, wage and profit are lower than they would be without EWT.

If the enterprise profit is totally or partially transferred to the government, then the government revenue also suffers from the decline in profits resulting from the imposition of EWT, which may or may not be wholly compensated by EWT revenue, because tax revenue with EWT is not necessarily greater than revenue without EWT. Tax revenue collected from the enterprise without and with EWT can be expressed as, respectively,

Comparison of (20) and (21) shows that T* ≥ T if

Since the condition in (22) need not hold in general, the imposition of EWT may well result in a net loss of tax revenue to the government. This is because even though the statutory tax base with EWT is broader, taxable profit is lower. ^13/

3. The incentive to avoid EWT

The enterprise may have the leeway to remunerate workers in ways that do not trigger EWT (see the Russian example below). For example, certain types of bonuses or overtime pay may not be included in the statutory EWT base and the excess of the wage bill over the hypothetical wage bill for EWT purposes may thus be lowered. Let us assume that all payments in excess of the minimum wage may be deducted as cost under the corporate income tax but only 0 < β < 1 portion of such payments is entered in the EWT base. Under these assumptions, the enterprise profit under EWT, denoted as, can be expressed as

If β = 0, all EWT liability is avoided; if β = 1, the EWT liability is paid in full. From (23), it can be shown that

for any b* > 0. Therefore, the greater the leeway to avoid EWT, the higher the profit and w*; hence both the enterprise and the workers have an incentive to collude in order to avoid EWT.

4. The incidence of EWT with two types of labor

Now suppose that the enterprise employs two types of labor, skilled and unskilled, denoted respectively by n₁ and n₂ Further assume that n₂ is paid the minimum wage whereas n₁ may be paid a wage, w₁, exceeding the minimum wage, that is, the enterprise takes $\overline{w}$ as given and chooses the level of w₁ and n₂. Then, from (3), the enterprise profit without EWT is

Maximizing (25) with respect to w₁ and n₂, we obtain

where f₁ and f₂ refer respectively to the marginal product of n₁ and n₂ and b₁ and b₂ to the increments exceeding the minimum wage paid to n₁ and n₂ and θ₁ refers to the elasticity of supply of n₁.

However, with EWT, and α = 1 as before, the enterprise profit from (6) is

Maximization of (27) yields

Under the assumption that θ₁ is constant, it is shown in appendix I that

that is, the wage and employment levels of skilled labor with EWT are lower than they would be without EWT. If the two types of labor are complementary (f₁₂ > 0), this result implies that the level of employment of n₂ is lower with EWT than it would be without EWT, therefore, output with EWT also is lower. Along with the results obtained in Section II.2, it can also be shown that the enterprise profit is lower, hence the incidence of EWT is both on the (skilled and unskilled) workers and the enterprise. Thus, if the skilled workers can be viewed as the managers, the managers also bear the burden of EWT along with the unskilled workers. Finally, the impact of EWT on tax revenue remains ambiguous as before.

5. The impact of EWT on inflation

The discussion in this section will be restricted to the homogeneous labor case discussed in Sections II.1 and II.2 where the analysis has been conducted under the assumption of constant prices. The same results hold with perfectly anticipated inflation since, given the inflation rate and the real minimum wage, the profit maximizing enterprise will adjust the nominal wage such that (13) and (14) hold. It is shown in appendix II that, in the absence of EWT, adjustment of the minimum wage with respect to inflation does not affect the equilibrium because $\begin{array}{c}\partial w/\partial \overline{w}\end{array}=0;$ however, the government’s minimum wage policy with respect to inflation affects the wage level under EWT because

This result is due to the fact that when $\overline{w}$ is increased the EWT base declines for any $w*>\overline{w}$ and the tax penalty for paying a wage exceeding the minimum wage is diminished at the margin. The result in (30) implies that, with EWT, the government has the leeway to lower the wage award granted by the enterprise by means of lowering the minimum wage. In an inflationary environment, this policy would amount to adjusting the nominal minimum wage, $\overline{W}$, at a rate less than the rate of inflation which would result in a lower real minimum wage and therefore a lower real wage paid by the enterprise exceeding the real minimum wage. ^14/ Therefore, even though EWT affords the government the facility to lower the wage award granted by the enterprise in the face of inflation, this happens at the cost of lower output since in this model lower w* implies a lower level of employment.^15/

Against the background provided by the foregoing observations, the relevant question is, can EWT result in a lower rate of inflation given the rate of increase in money supply? The following heuristic arguments indicate that the answer is negative.^16/ For simplicity, let us assume that all the enterprises in the economy are identical so that aggregate output of the economy, Y, is the sum of the outputs of z individual firms. Let us further suppose that capital stock is constant and the trend growth rate of the economy is zero. Then, the relationship in (30) indicates that aggregate output can be expressed as a function of the minimum wage as

At a point in time, suppose the equilibrium in the economy is determined by the Quantity Equation, MV = PY, where V is velocity, which is assumed to be constant, M is the money stock, and P is the price level.^17/ Substituting (31) into the Quantity Equation, we obtain

First, let us assume that M is constant. Given the minimum wage, when EWT is imposed, then the equilibrium real wage and aggregate employment level decline (w* < w, zn* < zn) and therefore aggregate output declines (Y* < Y). It follows that, given M, the price level jumps. ^18/

Price dynamics under EWT can be evaluated by taking the logarithm of (32) and differentiating with respect to time. Thus, it can be shown that the dynamic relationship between the price level and the minimum wage is

Of course, (33) does not represent a steady-state equilibrium since the minimum wage cannot decrease or increase indefinitely. However, it is possible to imagine that, for a period of time, the inflation adjustment in the minimum wage is such that the government allows the minimum wage to decrease (see the case of Poland below) or increase. As long as the minimum wage is adjusted with respect to inflation (ω = 0), the inflation rate is equal to the rate of money creation and (33) describes a steady-state equilibrium. If the minimum wage is allowed to decrease over a period (ω < 0), then output declines and the inflation rate exceeds the rate of money creation (ρ > μ). The reverse arguments hold if the minimum wage is adjusted such that for a period of time it increases and output rises and inflation rate declines.

The foregoing arguments indicate that, although instrumental in curbing the wage award by the enterprise in the face of inflation, depending on the government’s minimum wage policy, EWT can actually be pro-inflationary and even result in stagflation.

1. Homogeneous labor

Throughout Section II we assumed that the enterprise’s objective was profit maximization. However, this assumption may not be representative of the behavior of the state-owned enterprises. Such enterprises are often controlled by labor unions or, at least, unions exert decisive influence on management decisions.^19/ Therefore, alternatively, we may conjecture that the enterprise’s objective is to maximize its workers’ income subject to a profit constraint as determined by the government which owns the enterprise. In other words, we assume that the enterprise is under obligation to pay tax out of its gross profit and transfer a fixed net profit to the government. The profit constraint set by the government essentially corresponds to the extent to which the government is willing to support the enterprise. For example, if the profit target is set at a negative level, this would imply that the government is subsidizing the enterprise. Such a subsidy would likely be in the form of easy credit extended to the enterprise either directly by the government or through the state-controlled banking system. In this sense, the profit target can be interpreted as the parameter that establishes the extent to which the government is willing to impose a hard budget constraint on the enterprise.

As regards the wage and employment policy of the labor-dominated enterprise, two simple cases are considered. In the first case, we assume that the enterprise takes the present level of employment as given and does not lay off workers and, at the same time, the workers supply labor inelastically; that is, the number of workers employed by the enterprise is given. This conjecture appears to be roughly representative of the employment policy of the state-owned enterprises in the FSU which are either unable to or unwilling to effect lay-offs and alternative employment opportunities for the workers of the enterprise are very limited. In the second case, we assume that the enterprise has the leeway to set the wage level and, as the wage level is adjusted, the workers either choose to work fewer (more) hours or some workers choose to quit (enter) the work force. The second conjecture is given impetus by the presence of early retirement options, retraining possibilities, unemployment and welfare benefits. ^20/ The decline in labor supply can also be interpreted as a decline in work effort, and conversely. We maintain the assumption that labor supply is less than perfectly elastic, as assumed in Section II.

In the first case, suppose the government sets the profit target at π^g, a constant. Then, without EWT, from (7), w can be expressed as and, with EWT, from (8), w* can be expressed as

Comparison of (34) and (35) (given the same n, $\overline{w}$, π^g, and r) shows that

that is, EWT serves to lower the wage level. ^21/ This result obtains for the simple reason that the government increases the tax base without lowering its profit share and the additional tax is paid by the workers. ^22/ In either case, the government has the leeway to choose π^g such that $w=\overline{w}\mathrm{or}w*=\overline{w},$, therefore, the effect of EWT on wages is moot. Further, it is clear that the lower the profit target set by the government, the higher the wage with or without EWT. It is therefore in the interest of the workers to understate the profit of the enterprise to increase their wages. This opens the possibility of a wage bargain between the enterprise and the government in the process of deciding the level of π^g. If the government does not have the capacity to monitor the enterprise profits adequately and may therefore be inclined to settle for a lower profit transfer than targeted (or if the government lacks the political will to lower subsidies to the enterprise), the enterprise may attempt to “negotiate” a lower profit transfer (or a higher subsidy level) to maximize the workers’ wages. ^23/ While the effect of EWT in this case is moot, it nevertheless affords the government an additional bargaining chip; for example, with EWT, the government might settle for a lower π^g than it would without EWT and attempt to make up the difference indirectly with additional revenue from EWT.

In the second case, the enterprise maximizes the workers’ income (wn without EWT or w*n* with EWT) by choosing the wage level. Elastic labor supply implies that the level set for π^g by the government cannot exceed the maximum profit levels implied by the maximization of (7) and (8), that is, π_max without EWT, and π_max with EWT. If the government chose π^g = π_max without EWT or π^g = π*_max with EWT, the enterprise would choose w and w* exactly at the levels found in Section II.1.b; therefore, w* < w hence w*n* < wn. If the government chose π^g < π_max or π^g < π*_max, then w and w* would be higher than before with w* < w; hence the workers income would also be higher. However, if the government chose π^g > π_max or π^g > π*_max, then the enterprise would be unable to achieve the profit target set by the government. ^24/ Therefore, in this case also, the effect of EWT on the wage level is moot and the wage, output and employment levels depend on the profit target (or the subsidy level) chosen by the government.

2. Self-seeking managers

The model in Section III.1 can be extended to the heterogenous labor case to shed light on the behavior of self-seeking SOE managers. It has been argued that EWT provides an incentive to managers to avoid the tax by averaging in a few high salaries—those of the managers— with many low salaries —those of the workers. Let us assume that the enterprise now employs two types of labor, skilled labor or the managers, n₁, and unskilled labor or the workers, n₂. Then, the managers’ wages without and with EWT, w₁ and w*₁ can be expressed as, respectively,

where π^g is the profit level required by the government. Suppose that, n₁ is given, that is, the managers are ensconced in their positions and have the collective power to maximize their wages, w₁ or w*₁, by choosing the level of w₂.

If labor shedding is not possible, that is, if the level of n2 is given, then it is clear from (37) and (38) that the managers will prefer to pay as small a wage as possible to the workers, which is the minimum wage. ^25/ Perhaps in this sense, it would be possible to argue that EWT would result in a few managers surrounding themselves with many low-wage workers in order to avoid the tax. In this case, by substituting $\overline{w}$ for w₂ in (37) and (38), it is possible to show that

that is, for the same π^g, EWT lowers the managers’ wages. However, the impact of EWT on the managers’ wages is moot because the government has the leeway to choose π^g such that the managers’ wage obtains at a desired level $(w_1,{w*}_1\ge \overline{w})$.

If labor shedding is possible, then the managers can choose the level of w₂. Assuming, as before, that the supply elasticity of n₂, θ₂, is between zero and infinity, maximization of (37) and (38) with respect to w₂ yields, respectively,

Along the lines of the arguments leading to the result in (18) in the case of the profit-maximizing enterprise, it can be shown from (40) and (41) that

This result holds because now the managers are behaving as “profit” maximizers by maximizing their wage and they pay the workers lower wages because with EWT the marginal cost of n₂ is higher. So, when labor shedding is possible, the analysis indicates that self-seeking managers would shed labor to maximize their own income. In this case, we can also show that w*₁ < w₁. ^26/ However, again, the impact of EWT on the managers’ wages is moot since the level of such wages can be manipulated by the government through choosing the level of π^g. ^27/ In practice, management and workers are likely to connive to subvert the EWT (see the Russian example below).

Whether or not labor shedding is possible, the incidence of EWT is unambiguously both on the workers and the managers. The government has the leeway to choose the level of π^g in order the control the managers’ wages; the lower π^g the higher is the managers’ wages. Hence the managers have an incentive to conceal the level of profits and “bargain” for lower profit targets or higher subsidies. Therefore, the relevant question is one of fiscal discipline or the “hardness” of the budget constraint imposed on the enterprise by the government as the ultimate owner of the enterprise.

Another related issue concerns possible preventive impact of EWT on malfeasance by the managers in stripping the assets of the enterprise. Asset stripping can be accomplished by means of excess wage payments during the course of privatization when property rights are rather ambiguous. One possibility is that the managers foresee that the government cannot or will not subsidize the enterprise indefinitely (that is, the government will not settle for low or negative levels of π^g). Then, an option may be to gradually sell the enterprise assets and pay the proceeds to the workers (or at least to the favored workers) in the form of excessive wages. ^28/ Since EWT discourages wage payments in excess of the norm, it may be instrumental in preventing asset stripping by the managers. For the managers to prefer a bankruptcy bonanza, they would have to figure that the present value of the proceeds in the process of bankruptcy (plus the present value of the wages they expect to make from alternative employment) is somehow larger than the present value of the wages they expect to make in their current positions if they did not bankrupt the enterprise. The present value calculations may well favor bankruptcy and, in some fashion, the managers can become “corporate raiders”. However, this does not appear feasible or realistic in the context of the transition economies because, first, by and large, the market institutions and political will to facilitate bankruptcy of SOEs do not exist; second, the process is too conspicuous; and third, alternative employment opportunities of an overwhelming majority of workers, including the managers, may be limited. Therefore, the preventive impact of EWT on asset stripping appears to be at best marginal (see the evidence and discussion below on the experience of Poland).

1. Poland

The experience of Poland is a good example and the most recently documented. To contain the growth of wages, a tax on “inflationary” or “excessive” wage growth was in force until the end of 1988. ^29/ This was levied on the profit of enterprises in which the total wage bill exceeded a certain norm. The tax equalled 100 to 500 percent of the excess over the permitted growth of wages, and 200 to 400 percent for awards and premia paid from after-tax profits. In 1989, this tax was abolished in favor of a regulation that wages exceeding a ceiling fixed by the Council of Ministers by executive order were subject to an “income tax increased by 200 percent” (Fiszer (1991)). In January 1990 a new law was introduced. Excessive wage growth was taxed at progressive rates from 200 to 500 percent, while above-ceiling premia paid out of after-tax profits were taxed at 500 percent. In January 1991, another new law on taxing inflationary wage growth was introduced. The principles were similar to the law that existed before 1989, with the difference that tax payments were tied to progress on privatization, and that the average wage rather than the total wage bill was made the reference point.

The law only applied to state-owned enterprises. The excess of the average wage of a state enterprise in any month over a norm set by the Council of Ministers with reference to the development of average wages in the economy, was subjected to a progressive tax with rates between 100 percent (for exceeding the norm by up to 3 percent) and 500 percent (for exceeding the norm by more than 5 percent). On the face of it, this system was quite restrictive as the inflation indexation coefficient on the norm was 0.6 during 1991-92. In fact, however, the policy was not particularly restrictive as the actual implementation of the EWT allowed for special exemptions, adjustments, and nonindexed linked modifications to the norm. This, together with the apparent willingness of many enterprises to pay the tax, led to significant increases in nominal wages. For example in 1990, the average wage typically exceeded the norm, particularly towards the end of the year.^30/

Although EWT revenue represented some 1.5 percent of GDP in 1992, state enterprises accumulated large EWT arrears. In 1991 accrued EWT liabilities amounted to Zl 39 trillion, but actual collections amounted to only Zl 27 trillion; about 50 percent of all outstanding tax arrears were EWT arrears. It was clear that some large state owned enterprises simply refused to pay the full EWT due. The arrears were concentrated in a few large state enterprises, such as the State Railroad Company (PKP) and the State Airlines (LOT), which, incidentally, were the same companies that also received large amounts of subsidies. By the end of 1993, “Popiwek” arrears amounted to over one percent of GDP (Schwartz, 1994, p. 9).

As regards the incidence of PPWW in Poland, evidence provided by Pinto (1992a) is illustrative. Three sets of SOEs during January to June 1992 have been analyzed: those having a positive net profit; those with a positive gross profit but negative net profit; and those with a negative net profit. Table 2 shows that tax arrears as a percentage of taxes due have been most substantial and have grown fastest for those firms that are the least profitable.

Table 2.

Tax Arrears Relative to Taxes Due

(In percent)

^1/First six months.

Table 2.

Tax Arrears Relative to Taxes Due

(In percent)

Profits	1990	1991	19921/
Positive net	1.8	3.3	3.7
Positive gross, negative net	0.2	17.4	26.8
Negative net	5.0	42.7	50.8

^1/First six months.

View Table

Table 2.

Tax Arrears Relative to Taxes Due

(In percent)

Profits	1990	1991	19921/
Positive net	1.8	3.3	3.7
Positive gross, negative net	0.2	17.4	26.8
Negative net	5.0	42.7	50.8

^1/First six months.

Further, Table 3 shows that average wages were larger and increased faster in the more profitable firms.

Table 3.

Average Wages for Selected Months

(Thousands of zlotys per worker)

Table 3.

Average Wages for Selected Months

(Thousands of zlotys per worker)

Profits	Dec. 1989	June 1980	Dec. 1990	June 1991	Dec. 1991	June 1991
Positive net	658	918	1,568	1,573	2,178	2,169
Positive gross, negative net	765	1,014	1,763	1,334	1,885	2,017
Negative net	603	852	1,395	1,440	1,737	1,858

View Table

Table 3.

Average Wages for Selected Months

(Thousands of zlotys per worker)

Profits	Dec. 1989	June 1980	Dec. 1990	June 1991	Dec. 1991	June 1991
Positive net	658	918	1,568	1,573	2,178	2,169
Positive gross, negative net	765	1,014	1,763	1,334	1,885	2,017
Negative net	603	852	1,395	1,440	1,737	1,858

The PPWW per worker accrued (but not necessarily paid—see Table 2) shown in Table 4 suggests that the most profitable firms have paid the highest excess wage taxes. This is consistent with the earlier analysis (Section II.2) and indicates that EWT penalizes the more productive enterprises and that EWT in Poland did not prevent the profitable companies from paying wages exceeding the norm. EWT’s cost was borne by successful SOEs while those with lower average wage payments and decapitalization coped with their PPWW liabilities by running up arrears.

Table 4.

PPWW per Worker

(Thousands of zlotys)

^1/First six months.

Table 4.

PPWW per Worker

(Thousands of zlotys)

Profits	1990	1991	19921/
Positive net	3,665	6,500	1,635
Positive gross, negative net	5,675	4,740	219
Negative net	1,319	1,518	256

^1/First six months.

View Table

Table 4.

PPWW per Worker

(Thousands of zlotys)

Profits	1990	1991	19921/
Positive net	3,665	6,500	1,635
Positive gross, negative net	5,675	4,740	219
Negative net	1,319	1,518	256

^1/First six months.

Further evidence suggests there is no direct connection between PPWW liability and running down the capital stock of a company. Although the least profitable firms were running down their capital, this could not be ascribed to PPWW payments, as the most profitable firms had the highest PPWW liabilities and almost zero arrears.

There is also evidence that, as predicted by our model, real wages and employment (although no doubt influenced by many more prominent factors such as credit and interest rate policies) declined after PPWW was introduced, especially in the high-productivity industries.^31/

In view of the decline in the wage norm, our model would also predict a decline in output-employment level and hence a rise in the inflation rate, given the rate of money creation. However, the evidence on the impact of EWT on inflation is inconclusive. Pinto (1992b) argues that the effectiveness of the wage policies under EWT in controlling inflation is suspect. In contrast, Blanchard and Layard (1992) argue that, in the absence of the incomes policy effected through EWT, there would be an increase in the inflation rate.

A disadvantage of the Polish EWT has been the tendency of the government to fine tune the PPWW by introducing narrow exemptions from EWT. A 100 percent exporter can be exempted from PPWW; this led, for instance, to a rush to export semi-processed steel, cutting domestic supplies and also hurting finished steel producers. Again, in 1993 enterprises were allowed to negotiate exemptions with local tax chambers for exemption from the PPWW in light of their individual wages policies. An overwhelming criticism of the PPWW was the relative and partial way it was administered. Numerous examples of discrimination could be cited. ^32/ SOE managers had a strong preference (59 out of 63 sampled) for a wage bill formula rather than the average wage norm. If the PPWW was to be retained, managers wanted uniform enforcement, no forgiveness for arrears, and no exceptions. Managers proposed that PPWW should be simplified and a maximum rate of 100 percent should be used. On this issue, the IBRD study concludes: “A more positive way of inducing firms to focus on profits and long-run health is to simplify the PPWW ... and link managerial compensation to profits, at the same time clarifying the position and rewards for management following privatization so that the maximization of the firms’ value becomes paramount” (Pinto (1992a), p. 29). Of course, this begs the question of why, if managers are to be driven by a focus on profits, they should need any artificial excess tax on wages. Presumably, given a credible timetable for privatization, the SOEs will pay those wages that will maximize profits in the medium term?

It has been proposed to move away from the PPWW system in 1994 to a form of trilateral wage bargaining (government, workers, employers). ^33/ Given the long history of such arrangements (for example, the Netherlands in the 1950s and 1960s), this may be wishful thinking as a solution to wage-cost control. A better solution would be to face up to the lack of financial discipline in some fifty SOE’s and impose stringent financial controls, including the potential for ultimate bankruptcy.

2. Azerbaijan

As shown in Table 1, the Azerbaijan EWT norm is four times the minimum wage and levied at the corporate profit tax rate of 35 percent. Because the corporate tax rate structure is progressive in Azerbaijan, the marginal rate at which excess wages can be taxed can be as high as 70 percent. So the rate at which EWT is levied varies not only according to the size of the wage bill, but also according to the size of profits and hence is further distorted between different enterprises at different times. It was reckoned that about a quarter of the profits tax revenue was attributable to EWT (some 3 to 4 billion rubles in 1992). Arguably, an EWT that generates substantial revenue is not working well to discourage wage awards. The reasons for this apparent failure in Azerbaijan are threefold. First, SOEs in a monopoly position regard EWT as a cost and pass it forward in price increases. Second, lack of financial discipline and generous credit expansion allow full pass-through of costs. Finally, rapidly accelerating inflation means that calculations based on a minimum wage that is quickly out of date are mostly irrelevant to the wages paid to skilled workers.

3. Belarus

In Belarus, both SOE managers and the government viewed EWT as a badly focussed tax, that is, distortionary, widely evaded, and difficult to administer fairly. The most potent criticism of EWT in Belarus is that the authorities abolished the tax in late 1992. This reflects a widespread view of EWT in countries that have had to use them for many years (Hungary).

4. Bulgaria

The 1994 table for the rates of EWT below is a good illustration of how the tax operates.

Table 5.

Bulgaria: EWT

Note: Tax rates are distributed in four groups (columns) depending on the minimal wage established in the country for the respective quarter or 1994.

Table 5.

Bulgaria: EWT

	Tax Rate Depending on the Average Monthly Gross Wage for the Respective Quarter of 1994 (in percent)
Percentage Increment of Wage Funds Compared to the Basic Reference Amount	Up to 2 Minimal wages	Up to 3 Minimal wages	Up to 4 Minimal wages	More than 4 Minimal wages
Up to 2	—	—	—	—
More than 2 up to 3	10	50	75	100
More than 3 up to 4	20	75	100	200
More than 4 up to 5	50	100	200	600
More than 5	100	200	600	800

Note: Tax rates are distributed in four groups (columns) depending on the minimal wage established in the country for the respective quarter or 1994.

View Table

Table 5.

Bulgaria: EWT

	Tax Rate Depending on the Average Monthly Gross Wage for the Respective Quarter of 1994 (in percent)
Percentage Increment of Wage Funds Compared to the Basic Reference Amount	Up to 2 Minimal wages	Up to 3 Minimal wages	Up to 4 Minimal wages	More than 4 Minimal wages
Up to 2	—	—	—	—
More than 2 up to 3	10	50	75	100
More than 3 up to 4	20	75	100	200
More than 4 up to 5	50	100	200	600
More than 5	100	200	600	800

Note: Tax rates are distributed in four groups (columns) depending on the minimal wage established in the country for the respective quarter or 1994.

The regulations under the Bulgarian EWT (appendix IV) show that this is no simple tax to administer, suggesting that compliance costs must be considerable. Under Article 3 of the regulations, there are six ways of establishing the basic reference amount of the wages depending on whether the volume of sales has increased or decreased, whether debts and arrears have changed, and a choice of appropriate coefficients.

In contrast to Azerbaijan, if low revenue indicates EWT is working to restrain wage awards, then Bulgaria has a success story on its hands. In 1991 the revenue collected from EWT was equal to about 0.4 percent of GDP, equivalent to about 5 percent of the revenues from social security contributions; the figures were similar for 1992. However, perhaps the greater competition and better credit control explains more of the wage restraint than the impact of EWT.

5. Estonia

The intent of the Estonian EWT is to allow real wages to be maintained but to penalize any increase above the expected inflation guidelines. Average employee compensation is defined as gross incomes per employee. Gross incomes includes salaries, premia, cash and in-kind support, interest subsidies, distributed profits and incomes from company shares. Revenue has been negligible. Once again, the Estonian economy has been more open to competition and wages appear to have been restrained not so much by EWT as by the extremely tight credit availability enforced through the Estonian Currency Board.

6. Hungary

Hungary has a long history of using EWT, based on both the wages bill and the average wage.^34/ Again, like Belarus, the most convincing commentary may be that the government abolished EWT as of January 1992. The tax was more sophisticated than in many countries including allowances for performance indicators limiting the permissible wage increase to gross value added and profitability. Separate schemes, at times, allowed for wage increases for enterprises subject to competitive pricing rules and for agriculture. Most recently, wage increases exceeding the increase in the value-added of the firm were not treated as costs and were taxed at the corporate rate. Boote and Somogyi argue that “wage regulation schemes largely prevented sizable wage overruns associated with loose financial discipline” (pp. 18-19). Increasing competition from the private sector (not liable to EWT) required the SOEs to pay wages differentiated according to productivity and efficiency; the EWT had become a constraint on remodelling the public sector industries. Moreover, it was clear that the administration of this tax was difficult and it was resented by managers, especially thrusting and modernizing managers. Increasingly, the EWT had become irrelevant in containing wage growth in public enterprises.

7. Kazakhstan

Parliament rejected the EWT sought by the administration in May 1992. They did so for at least three reasons: widespread recognition that other countries experience with EWT had been disappointing; intensive lobbying by enterprises against the new tax; and, strong doubts about the ability of the tax administration to apply and monitor EWT.

8. Kyrgyzstan

If small revenues are to be a measure of EWT’s success, the Kyrgyzstan tax is working well. In 1991 it is reckoned that revenue from EWT was about 1.7 percent of total revenue from the enterprise profits tax. Of course, this could also be an indication that the tax administration was simply failing to assess and collect the tax.

9. Latvia

The revenue from EWT in 1992 seems to have been small (0.4 percent of total central government revenue). The success in controlling wage increases is probably due more to a tight monetary policy and to extremely depressed demand. Most recently, the authorities introduced an amendment so that increases in productivity (defined as the change in real output divided by the change in employment) would not be subject to EWT. It was also suspected that if trade started to expand, firms would start to evade EWT.

10. Russia

The Russian authorities agree that EWT’s objective is not to raise revenue but to encourage enterprises to use profits for investment rather than excessive wage payments. ^35/ The enterprises’ profits tax for the quarter is paid in advance. In principle the enterprise should incorporate an estimate of its excess wages tax to be taxed under the enterprise profits tax. It is unclear whether this is, in fact, calculated. However, in the month following each quarter the enterprise profits tax and EWT is computed based on actual profits, wages, and the norm for the previous quarter. An immediate settlement is made by the enterprise. It is thought that EWT is less than it might be as enterprises increase nonwage compensation to labor in the form of payments to pensions funds, vacation funds and other employer-provided benefits.