اصلاحات مالیاتی و عملکرد بازار کار در منطقه یورو: آنالیز مبتنی بر شبیه سازی با استفاده از مدل جدید در سطح منطقه

In this paper, we employ a calibrated two-country version of the New Area-Wide Model (NAWM) developed at the European Central Bank to examine the potential benefits and spillovers of reducing labour-market distortions caused by euro area tax structures. Our analysis shows that lowering tax distortions to levels prevailing in the United States would result in an increase in hours worked and output by more than 10%. At the same time, tax reductions would have positive spillovers to the euro area's trade partners, bolstering the case for tax reforms from a global perspective. Finally, we illustrate that, in the presence of heterogeneous households, distributional effects may be of importance when gauging the impact of tax reforms.

What are the important driving forces and economic mechanisms behind the cross-country differences in labour utilisation that have emerged over the recent decades? This question has triggered an intense debate about institutions versus preferences as potential explanations of lower labour utilisation in Europe relative to the United States. Prescott (2004) argues forcefully that institutions, and in particular taxes on labour income, are the main explanation for lower labour utilisation in Europe, as measured by the average number of hours worked. In contrast, Blanchard (2004) suggests that European preferences for leisure are an important determinant of the observed downward trend in hours worked. Similarly, Alesina et al. (2006) claim that Europeans work much less because of the influence of trade unions in the seventies, eighties and part of the nineties (partly reflecting preferences for social cohesion) and because of widespread labour-market regulations creating disincentives to work. In this paper, we start from Prescott's (2004) analysis and ask the counterfactual question of what would happen in terms of hours worked and overall economic performance if the labour-market distortions originating in European tax structures were to be reduced to levels prevailing in the United States. To answer this question, we employ a calibrated two-country version of the New Area-Wide Model (NAWM) developed at the European Central Bank.1 The specification of the NAWM builds on recent advances in developing micro-founded DSGE models suitable for quantitative policy analysis, as exemplified by the closed-economy model of the euro area by Smets and Wouters (2003), the International Monetary Fund's Global Economy Model (GEM; cf. Bayoumi et al., 2004) or the Federal Reserve Board's new open-economy model named SIGMA (cf. Erceg et al., 2005). Thus, it incorporates numerous nominal and real rigidities in an effort to improve its empirical fit regarding both the domestic and international dimension. The employed version of the NAWM consists of two symmetric countries of different size: the euro area and the United States, the latter representing the rest of the industrialised world. International linkages arise from the trade of goods and international assets, allowing for imperfect exchange-rate pass-through and financial intermediation costs. Thus, the model permits us to also gauge the international repercussions that may arise from the reduction of labour-market distortions.2 In addition, building on Coenen and Straub (2005), the NAWM features two distinct types of households which differ with respect to their ability to participate in asset markets, with one type of household only holding money as opposed to also trading bonds and accumulating physical capital.3 Due to the existence of these two types of households, fiscal policies other than government spending – notably transfers – have real effects even though both types of households are optimising subject to intertemporal budget constraints. Indeed, transfer policies are found to have noticeable income effects, in particular if the distribution of transfers across households is skewed towards those that are constrained regarding their ability to access asset markets.4 At the same time, with an empirically realistic share of constrained households equal to 25%, the NAWM does not generate the magnitude and persistence of the crowding-in effect on consumption that some empirical studies have documented (see, e.g., Perotti, 2004 and Mountford and Uhlig, 2005), at least for sample periods preceding the 1990s. As regards the labour market, it is assumed that both types of households supply differentiated labour services and act as wage setters in monopolistically competitive markets by charging a markup over their marginal rate of substitution. Specifically, wage setting is characterised by sticky nominal wages à la Calvo (1983) as well as indexation, resulting in two separate wage Phillips curves.5 For the purpose of the present study, particular emphasis is given to quantifying the various labour-market distortions originating in national tax structures. In this context, we focus on three major government revenue components that drive a wedge between the effective consumption wage of households (the purchasing power of the after-tax wage) and the effective labour cost of firms: income taxes, social security contributions (both employers’ and employees’), and indirect taxes on consumption goods. The size and composition of this tax wedge differ markedly across the euro area and the United States (see OECD, 2004 and OECD, 2004; and our own calculations presented below). While the overall tax wedge in the euro area currently amounts to roughly 64% of the earnings of an average production workers, that of the United States is limited to about 37%. Also, the way governments raise revenue differs considerably across the euro area and the United States, with employers’ social security contributions for example accounting for 22% of earnings in the euro area versus 7% in the United States. As argued by Prescott (2004), the existing large differences in the overall tax wedge across the euro area and the United States (possibly more than its composition) should essentially explain the euro area's relatively poor performance in terms of labour utilisation when compared to the United States. Indeed, many empirical studies (see for instance those surveyed in IMF, 1999, European Commission, 2004 and Nickell, 2004) report detrimental effects of tax wedges on labour-market outcomes in Europe. Thus, lowering the euro area tax wedge to the level prevailing in the United States ought to lead to a significant rise in labour utilisation and, thereby, to an improvement in overall economic performance.6 How a reduction in the tax wedge will exactly affect labour utilisation and overall economic performance, however, will largely depend on the particular characteristics of the economy, notably the elasticity of labour supply and the details of the wage-setting process, but also on how the implied losses in revenue are financed and the importance of international spillovers. Hence, a systematic quantitative assessment using a well-articulated dynamic model like the NAWM seems central to making progress towards a better understanding of the effects of tax reforms on labour-market performance.7 Our assessment based on the NAWM confirms the widely held view that reductions in tax distortions have beneficial effects on labour-market outcomes and general economic performance. In fact, lowering euro area tax wedges to levels prevailing in the United States is found to result in a rise in hours worked and output by more than 10% in the long run. At the same time, our analysis shows that tax reforms aimed at reducing labour-market distortions would have beneficial spillovers to the euro area's trade partners, bolstering the case for such reforms from a global perspective. Further, we demonstrate that the existence of nominal and real rigidities results in plausible adjustment dynamics over short to medium-term horizons following a reduction in tax distortions. In the absence of these rigidities, a reduction in distortionary tax rates would lead to adjustment paths that are characterised by sizeable impact responses and overshooting – outcomes that we consider as rather unrealistic. For instance, if the favourable supply-side effects were to be dominated by demand effects due to the implied increase in permanent income, pronounced inflationary pressures would arise in the short to medium run, triggering an excessive tightening of monetary policy. Finally, we illustrate that, in the presence of heterogeneous households, distributional effects may be of importance when gauging the macroeconomic impact of tax reforms which, in the first place, are designed to meet efficiency considerations. The remainder of the paper is organised as follows. Sections 2 briefly characterises historical developments in labour-market outcomes in the euro area relative to the United States and documents cross-country differences in tax distortions. Section 3 outlines the specification of the NAWM, while Section 4 provides details on its calibration, together with some dynamic simulations illustrating its dynamic properties. Section 5 employs the NAWM to evaluate the benefits and spillovers of reducing the labour-market distortions caused by euro area tax structures to levels prevailing in the United States. Finally, Section 6 summarises our conclusions and suggests directions for future extensions.

To examine the effects of reducing labour-market distortions caused by euro area tax structures, we employed a calibrated version of the New Area-Wide Model developed at the European Central Bank. Using this model, we confirm the widely held view that reductions in tax distortions would have beneficial effects on labour-market outcomes and overall economic performance. In fact, lowering euro area tax wedges to levels prevailing in the United States would lead to a rise in hours worked and output by more than 10% in the long run. At the same time, we show that tax reforms aimed at reducing labour-market distortions have beneficial spillovers to the euro area's trade partners, bolstering the case for tax reforms from a global perspective. Finally, we illustrate that, in the presence of heterogeneous households, distributional effects may be of importance when gauging the impact of tax reforms. A possible extension of our analysis would be to study the consequences of differences in productivity growth across the euro area and the United States. Such differences are perceived to be an important determinant of the employment and output (growth) differentials observed over more recent years. Another interesting avenue for future research would be to examine the consequences of differences in skill levels across the two types of households. High tax wedges seem particularly problematic for low-skill, low-productivity workers since it may be difficult for workers that are protected by minimum-wage or industry pay norms to fully accommodate any required wage correction.