Study: tax policies have little impact on employment

Income tax policies have only a limited impact on employment, such as the amount of work performed, concludes a report released on 26 January. Research carried out in Finland and abroad suggests that income taxes have little effect on earnings or the willingness to work longer hours, especially in regular employment. Consequently, the income tax reliefs implemented over the past few decades have only contributed to minor growth in employment and the tax base as compared to a situation with no tax breaks.

However, income taxation is found to a have considerable effect on the behaviour of certain special groups. Scientific literature shows that entrepreneurs, for example, seek to make arrangements to time their reported income so as to minimize taxes. According to the findings, changes in income taxation have little impact on the extent of the economic activities that entrepreneurs engage in (aggregate income, etc.), but it may have a significant impact on the size of the tax base and the amount of tax revenues. 

Conventional thinking says that decisions on engagement in the labour market would be highly responsive to amendments to tax or social security laws. However, scientific literature lends little support to the notion that the employment rate would increase significantly if the incentives for employment were slightly improved. Consequently, a slight increase in the incentives – for example by raising the earned income deduction available to all wage-earners – is basically an inefficient and expensive way of promoting employment.

Even though elasticity in labour market participation is not great, it varies considerably from one group to another. Therefore, the employment incentives should primarily be offered to those special groups that readily respond to the incentives. For example, labour market participation by mothers with small children has been found to be highly responsive to the level of child care allowances.

The report was prepared as part of the implementation of the Government Plan for Analysis, Assessment and Research for 2014. The project’s objective was to assess the impact of tax policies on the supply of labour based on scientific research carried out in Finland and abroad. The project is part of the analysis and assessment activities in support of economic policy. The report was authored by Tuomas Matikka, Jarkko Harju and Tuomas Kosonen. The authors work as senior researchers at the Government Institute for Economic Research (VATT). In this study, they focus on the evaluation of behavioural responses to tax incentives.

The report is available online at http://vnk.fi/julkaisu?pubid=8702 (in Finnish)

Inquiries: Senior Researcher Tuomas Matikka,[email protected], tel. +358 (0)44 371 9456