Unemployment, Growth and Taxation in Industrial Countries

IGIER Working Paper No. 122

61 Pages Posted: 13 Jan 1998

See all articles by Francesco Daveri

Francesco Daveri

University of Parma - Dipartimento di Economia; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Guido Tabellini

Bocconi University - Department of Economics; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research; Center for Economic Studies and Ifo Institute for Economic Research (CESifo)

Date Written: November 1997

Abstract

To the layman, the upward trend in European unemployment is related to the slowdown in economic growth. We argue that the layman's view is correct. The increase in European unemployment and the slowdown in economic growth are related because they stem from a common cause: an excessively high cost of labor. In Europe, labor costs have gone up for many reasons, but one is particularly easy to identify: higher taxes on labor. If wages are set by strong and centralized trade unions, an increase in labor taxes is shifted onto higher real wages. This has two effects. First, it reduces labor demand and thus creates unemployment. Second, as firms substitute capital for labor, the marginal product of capital falls; over long periods of time, this in turn diminishes the incentive to accumulate and thus to grow. Thus high unemployment is associated with low growth rates. The model also predicts that the effect of labor taxation differs sharply in countries with different labor market institutions. We test these predictions on data for 14 industrial countries between 1965 and 1991 and find striking support for them. In particular, labor taxes have a strong positive effect on unemployment only in Europe and not in other industrial countries. The observed rise of 9.4 percentage points in labor tax rates can account for a reduction of the EU growth rate of about 0.4 percentage points a year--about one third of the observed reduction in growth between 1965-75 and 1976-91--and a rise in unemployment of about 4 percentage points.

JEL Classification: E6, H3, J3, J6, O5

Suggested Citation

Daveri, Francesco and Tabellini, Guido, Unemployment, Growth and Taxation in Industrial Countries (November 1997). IGIER Working Paper No. 122. Available at SSRN: https://ssrn.com/abstract=52787 or http://dx.doi.org/10.2139/ssrn.52787

Francesco Daveri (Contact Author)

University of Parma - Dipartimento di Economia ( email )

Via Kennedy 6
Parma, Parma 43100
Italy
+39 0521 032432 (Phone)
+39 0521 032402 (Fax)

HOME PAGE: http://www.igier.uni-bocconi.it/daveri/

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy
+39 02 5836 3325 (Phone)
+39 02 5836 3302 (Fax)

Guido Tabellini

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Center for Economic Studies and Ifo Institute for Economic Research (CESifo)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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