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Prepared by Victor Lledó (FAD) and Keiko Honjo (RES).
Low-skilled (high-skilled) individuals are defined here as those without upper secondary education (with tertiary education). Low (high)-paid and low (high)-skilled will be used interchangeably hereafter. Although the association is far from perfect—low-skilled workers in Spain earn on average just over half of high skilled wages (OECD, 2013)—, it will likely be reinforced following recent increases in the skill premium (Bonhomme and Hospido, 2012).
This will be particularly the case if the indirect impact of such tax reductions may have on labor demand through increases in aggregate consumption fails to materialize.
See Informe Comisión de Expertos para la reforma del Sistema Tributario Español. Available via the Internet: http://www.abc.es/gestordocumental/uploads/economia/fe007a24af859ec8ce790387ba6b7755.pdf
Heterogeneity is, therefore, only captured indirectly, a limitation of the model that should be acknowledged.
Absent sticky wages, the increase in labor demand following a reduction in labor costs brought with lower labor taxes would have no employment impact, as it would be immediately reversed by instantaneous wage increases.
As it is standard in other macro-simulation models tax rates are defined as implicit or average effective tax rates. Such rates capture more closely the actual burden from major taxes once exemptions, allowances, credits, progressive schedules, and other specificities of the tax are taken into account. They are not equivalent to statutory or nominal rates. The average effective labor tax rate is measured as the ratio of total revenues from labor income taxes and social security contributions to total wages. The average effective consumption tax rate is defined as the ratio of general consumption taxes on goods and services, including value-added and excise taxes, to total consumption.
Firms could do that to reduce their contribution liabilities by reporting as low-paid, workers with salaries above the contribution threshold. They could also agree to pay such workers a reported salary below the contribution threshold to be complemented by an unreported additional payment. This would, of course, not hold if the government could fully observe reported and unreported wage payments among the beneficiaries of the targeted ESSC. Firms would also have fewer incentives to misreport the larger their demand for truly low-paid workers would increase as the result of reductions in ESSC. Full government information about firm payrolls and high demand elasticities for the low-paid would favor a less graduated approach.
This depends of course on how distortionary social contributions are in the first place. The weaker the link between contributions and entitlements the more distortionay they are, the greater the employment impact of a reduction in ESSC is likely to be.