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Prepared by Alun Thomas
According to the OECD Jobs Study, the average tax wedge in Sweden was approximately 50 percent in the early 1990s, compared to an OECD average slightly above 30 percent.
Sweden is in the process of modifying its pension system to allow for defined contributions, with a further increase in the employee contribution rate to 9.25 percent. See the accompanying paper on the pension reform for more details on this issue.
Data on the personal income tax was provided by Lennard Flood who has calculated an average tax rate from a sample of 8000 households over the 1983–93 period. Data for the other periods was estimated based on a relationship between the data supplied by Flood and the ratio of household direct taxes to gross wages.
In the case of an increase in payroll taxes, gross wage costs to the firm immediately rise by the amount of the tax. In situations where the personal income tax rate is increased, the incidence depends on the extent to which the unions can insulate themselves from an increase in the income tax rate through bargaining with employers for higher wages. Therefore, increases in the payroll tax have more direct effects on the gross wage than comparable increases in income taxes.
In a number of empirical applications productivity is also included as a determinant of wages. However, the inclusion of this variable makes it impossible to separately identify the labor demand and wage setting equations unless the system is recursive. Manning (1993) presents a number of theoretical models of the labor market that exclude productivity from the wage setting equation and argues that this exclusion allows the proper identification of both the labor demand and wage setting curves. We therefore adopt this approach in this paper.
This effect is found in the background paper on the wage bargaining structure in Sweden.
One thousand replications were conducted and averaged.
The delayed response of employment to changes in payroll taxes is the result of excluding contemporaneous variables from the system of equations to minimize endogeneity problems. Excluding the dummy variables has little effect on the impulse responses.