The impact of social security contributions on earnings: Evidence from administrative data in France, Germany, the Netherlands and the UK

Lead Research Organisation: Institute for Fiscal Studies
Department Name: IFS Research Team

Abstract

Surprisingly little is known about how social security (National Insurance) contributions (SSCs) affect earnings - for example, if employers' contributions are increased, to what extent and how quickly do they pass that on to employees in the form of lower earnings? At a time when governments in some countries are increasing SSCs in order to reduce budget deficits while others are moving away from employer SSCs amid concerns that they are detrimental to employment, having an understanding of their true effects is vital.
This project aims to provide new evidence on the effects of SSCs on earnings in France, Germany, the Netherlands and the UK. The research will exploit large administrative datasets in each country that span several decades and track the same individuals over time: these data have never before been used in cross-country analysis and offer the potential to advance our understanding of the impact of SSCs substantially.

In particular, we will address two related questions: the effects of SSCs on individuals' and firms' behaviour (labour supply and labour demand responses) and the economic incidence of SSCs (i.e. who bears the burden of them in the form of lower net income). We will try to distinguish between short-run and long-run effects, look for differences according to who is nominally liable for the tax (i.e. the employee or the employer) and how closely contributions are linked to future benefit entitlements, and explore the institutional features (such as wage bargaining processes, trade unions and minimum wages) that might affect these impacts. Looking at different countries and at different time periods will help to shed light on all of this, but we will also use several different methodologies and examine what we can learn from the results of the different approaches.

First, we will take a high-level look at the relationship over a long period in many countries between aggregate economy-wide measures of earnings and previous years' SSC levels.

Second, we will examine how far people in the UK, Germany, France and the Netherlands tend to be bunched around particular earnings levels where SSC rates change, and assess what we can learn from that about the extent to which earnings respond to the incentives created by SSC regimes.

Third, we will focus on reforms to SSCs in the four countries, looking at subsequent earnings growth of those affected by the reforms compared with earnings growth among similar but unaffected groups.
Fourth, we will create an economic model of individuals' job search activity and simulate the effects of SSC reforms.

Finally, we will divide the population in each of the four countries into groups based on age, sex, etc, and estimate the relationship between the average earnings of each group (in each country, in each year) and the average SSCs they faced.

Taken as a whole, this research programme will provide an exhaustive analysis of what experience across several countries over several decades can tell us about the impact of SSCs on earnings, resulting in a deeper understanding and a rich evidence base to inform future policymaking.

Planned Impact

The international relevance of the issues we examine and the cross-country nature of this research mean that the impact of this project will be felt internationally.

It will benefit academics, as described in the Academic Beneficiaries section - and any further research that is motivated or facilitated by our work may bring wider benefits of its own. But this project also has significant potential benefits directly for policymakers in the UK and elsewhere. At a time when governments in some countries are increasing SSCs in order to reduce budget deficits while others are moving away from employer SSCs amid concerns that they are detrimental to employment, having an understanding of their true effects is vital. Yet surprisingly little is known about how SSCs affect earnings. This project will yield new evidence on the effects of SSCs on earnings in France, Germany, the Netherlands and the UK. In particular, it will shed light on two related questions: the effects of SSCs on individuals' and firms' behaviour (labour supply and labour demand responses) and the economic incidence of SSCs (i.e. who bears the burden of them in the form of lower net income). We will try to distinguish between short-run and long-run effects, look for differences according to who is nominally liable for the tax (i.e. the employee or the employer) and how closely contributions are linked to future benefit entitlements, and explore the institutional features (such as wage bargaining processes, trade unions and minimum wages) that might affect these impacts. Taken as a whole, the research programme will provide an exhaustive analysis of what experience across several countries over several decades can tell us about the impact of SSCs on earnings and what factors the impact depends on, resulting in a deeper understanding and a rich evidence base to inform future policymaking.

Those outside government concerned with good policymaking and the impact of SSCs will also share these benefits: this includes business groups, trades unions, NGOs, think tanks and international organisations such as the OECD. The media and the public in general may benefit as we address issues at the centre of public debate and bring new evidence to the table.

Private firms and individuals might even benefit directly from a better understanding of how future changes to SSCs might affect their costs and incomes respectively - the extent to which the immediate effects of such changes might be offset (or even accentuated) by adjustments to earnings - as well as benefiting from any improvement in policy design.

Part of the benefits of this project will arise as the project goes on, since results from each stage of the project will be published as the later stages proceed. But the bulk of the benefits will be felt towards and after the end of the project, as the full picture becomes available and the different parts can be integrated into a unified narrative, and as the bulk of the dissemination activity described in the Pathways to Impact section takes place.
 
Description Our research has significantly advanced knowledge on how earnings are affected by National Insurance contributions (NICs) in the UK.
For at least 12-18 months after a reform, it appears that the burden of employee NICs is felt largely by the employee whose earnings are being taxed, while the burden of employer NICs is not: that is, in the short run gross earnings do not adjust to shift the burden/benefit of a change towards or away from the employee in question.
Most employees face frictions (such as adjustment costs or information barriers) which prevent them from fine-tuning their earnings to minimize their NICs liabilities, even in some cases when tax savings worth one sixth of their earnings are available. These frictions are larger for men, full-time workers and the public sector than for women, part-time workers and the retail and hospitality sectors.
However, some workers' earnings do respond to NICs incentives, with the overall size of behavioural responses broadly consistent with consensus estimates for income tax. In particular we find that employees respond to increases in their marginal rate of employee NICs by reducing their hours of work, with average hours of work falling by about 0.2-0.3% within 12-18 months for each 1% fall in their after-NICs hourly wage (holding their total income constant). Working hours do not appear to respond to changes in employer NICs rates in the same way, although employment rates might.
A careful review of the literature does not validate the widespread perception that evidence from cross-country differences in social security contributions supports the hypothesis that both employee and employer SSCs ultimately reduce workers' net earnings. Indeed, we find that this cross-country literature currently provides few clear and consistent conclusions at all, and we propose improvements to the commonly used data and methodology that might make future research in this area more fruitful.
We have also made methodological advances which will help future researchers. These include a method for decomposing bunching in the earnings distribution into hours-of-work and hourly wage components, better estimation of long-run effects in a panel analysis (by use of lags rather than long panels), and uncovering and highlighting important features and limitations of the little-documented Annual Survey of Hours and Earnings dataset which will be useful to other (academic and non-academic) users of the data.
The UK-specific research resulted in two major academic journal articles, one published in the Journal of Public Economics (and previously as a (US) National Bureau of Economic Research working paper) and the published in International Tax and Public Finance (and previously as an IFS working paper). The cross-country collaboration also resulted in a special issue of the journal De Economist, comprising articles using a consistent methodology to address the same question for each country. The UK team was involved in guest editing the special issue and contributing two articles to it. Close working with international partners also improved the quality of the individual-country studies, and strengthened links between our respective institutions and the individual researchers involved.
Exploitation Route Our findings are feeding directly into policy-makers' thinking, as discussed in the Narrative Impact section. We also hope that our academic outputs (including several academic journal articles, numerous conference presentations, etc.) will stimulate further research building on our findings. We held a major two-day academic workshop at the IFS in 2016, bringing together junior and senior researchers on this topic from around the world and concluding with a panel discussion on lessons learned and directions for future research, intended to encourage new research and particularly collaborations between attendees.
Sectors Government, Democracy and Justice

 
Description Our findings are of direct relevance and interest to tax policy makers. Stuart Adam, Principal Investigator on the project, completed a secondment to the Knowledge, Analysis and Intelligence division of HM Revenue and Customs shortly after the end of the project, which provided further opportunities to feed the findings of the research, and the associated expertise generated, directly into the policy-making process. Among other things, this included running a round-table with the project team and key HM Treasury and HMRC analysts and policymakers (including the Head of NICs policy at HM Treasury and the Head of Income Tax and NICs Analysis at HMRC) to present and discuss key findings from this project and from other work on responsiveness of high-income individuals to tax rates. We continue to be in contact with the relevant teams at HM Treasury and HMRC. Policy events were also held in partner countries: for example, our research was discussed along with those of our international partners at an event held at France Stratégie and attended by French MPs, civil servants, business and trades union representatives and others.
First Year Of Impact 2017
Sector Government, Democracy and Justice
Impact Types Policy & public services

 
Description Roundtable with HMRC and HMT on findings from recent IFS research on SSCs and income tax
Geographic Reach National 
Policy Influence Type Participation in a advisory committee
 
Description 35 years of reforms: A panel analysis of the incidence of, and employee and employer responses to, social security contributions in the UK 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact Presented at the Trans-Atlantic Public Economics Seminar in Mannheim on 13 June 2016.
Year(s) Of Engagement Activity 2016
 
Description Adjustment costs and labour supply: evidence from bunching at tax thresholds in the UK 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Other audiences
Results and Impact This presentation was delivered at the Public Economics UK conference (PEUK 2015), held at Exeter University on 4 September 2015.
Year(s) Of Engagement Activity 2015
URL http://www.ifs.org.uk/publications/7972
 
Description Adjustment costs and labour supply: evidence from bunching at tax thresholds in the UK 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact This presentation was delivered at the 71st Annual Congress of the International Institute of Public Finance (IIPF 2015), held at Trinity College, Dublin on 20-23 August 2015.
Year(s) Of Engagement Activity 2015
URL http://www.ifs.org.uk/publications/7971
 
Description Cross-country analysis: aggregate and cell-based approaches 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact This paper was presented at a workshop, 'The incidence and labour market effects of social security contributions', held at the Institute for Fiscal Studies in March 2016 and organised with colleagues from the Netherlands, France and Germany.
Year(s) Of Engagement Activity 2016
 
Description Frictions and the elasticity of taxable income: evidence from bunching at tax thresholds in the UK 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact This paper was presented at a workshop, 'The incidence and labour market effects of social security contributions', held at the Institute for Fiscal Studies in March 2016 and organised with colleagues from the Netherlands, France and Germany.
Year(s) Of Engagement Activity 2016
URL http://www.ifs.org.uk/events/1272
 
Description Frictions and the elasticity of taxable income: evidence from bunching at tax thresholds in the UK 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact This presentation was delivered at the 2016 Irish Economic Association conference at National University of Ireland, Galway.
Year(s) Of Engagement Activity 2016
URL http://www.ifs.org.uk/publications/8397
 
Description Frictions and the elasticity of taxable income: evidence from bunching at tax thresholds in the UK 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact This presentation was delivered at the Economic and Social Research Institute, Dublin on 14 April 2016.
Year(s) Of Engagement Activity 2016
URL http://www.ifs.org.uk/publications/8396
 
Description Frictions and the elasticity of taxable income: evidence from bunching at tax thresholds in the UK 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Other audiences
Results and Impact This presentation was delivered at the 2016 Annual Conference of the Royal Economic Society at the University of Sussex, Brighton.
Year(s) Of Engagement Activity 2016
URL http://www.ifs.org.uk/publications/8232
 
Description Roundtable with HMRC and HMT on findings from recent IFS research on SSCs and income tax 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Roundtable with HMRC and HMT on findings from recent IFS research on SSCs and income tax
Year(s) Of Engagement Activity 2017
 
Description The incidence and labour market effects of social security contributions 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other audiences
Results and Impact A workshop was held on Monday 29 February and Tuesday 1 March. It was organised by Stuart Adam, Institute for Fiscal Studies; Richard Blundell IFS and UCL; Nicole Bosch CPB, Netherlands; Antoine Bozio, Institut des Politiques Publiques, Paris School of Economics; Peter Haan DIW Berlin and Barra Roantree, Institute for Fiscal Studies

Social security contributions (SSCs) represent a very large share of total taxation in OECD countries (26.1% in 2013), yet empirical studies of their effects on earnings are surprisingly limited. This two-day academic workshop at the Institute for Fiscal Studies will feature 9 papers on the incidence and labour market effects of SSCs, alongside a panel discussion on lessons learnt and directions for future research.

These papers were presented:

- Barra Roantree (IFS): 'Frictions and the elasticity of taxable income: evidence from bunching at tax thresholds in the UK' (with Stuart Adam, James Browne and David Phillips). Slides, Discussant's slides

- Damon Jones (Chicago): 'Earnings adjustment frictions: evidence from the [US] social security earnings test' (with Alex Gelber and Dan Sacks).

-Michael Neumann (DIW): 'The role of aggregate preferences for individual labour supply: evidence from marginal employment in Germany' (with Luke Haywood).

- Nicole Bosch (CPB): 'Earnings responses to payroll and income taxation: evidence from variation in Dutch pension rates' (with Maja Micevska Scharf).

- Thomas Breda (IPP/PSE): 'Taxes and technological determinants of wage inequalities: France 1976-2010' (with Antoine Bozio and Malka Guillot).

- Enda Hargaden (Michigan): 'Taxpayer responses over the cycle: evidence from Irish notches'.

- Tuomas Matikka (VATT): 'The accuracy of bunching methods under optimization frictions: students' constraints' (with Tuomas Kosonen).

- Antoine Bozio (IPP/PSE): 'Incidence of social security contributions: Evidence from France' (with Thomas Breda and Julien Grenet).

- Michael Neumann (DIW) and David Phillips (IFS): 'Cross-country analysis: aggregate and cell-based approaches'.
Year(s) Of Engagement Activity 2016
URL http://www.ifs.org.uk/events/1272