Transcript Taxes, Hours and Employment

Taxes, Hours and Employment
Edward C. Prescott
Reykjavik, Iceland, July 26, 2007
Cutting Taxes to Increase Prosperity
Two Economic Diseases
–
Low productivity
–
Low market hours
Output per person is productivity times market hours
per person
2
Examination
Prescott, M.D.
3
Statistics for 2004 relative to U.S.
Economy
GDP per Person Hours per Person
16-64
16-64
GDP per
Hour
E.U.-15
69
78
89
U.S.
100
100
100
Japan
77
102
76
4
Diagnosis
• E.U.-15 has a case of the low labor supply disease
• E.U.-15 also has a mild case of the low productivity
disease
5
Is Europe Getting Sicker?
Decade Productivity Growths
1984-1994
1994-2004
Europe
20%
15%
U.S.
15%
21%
6
Answer
• Maybe there is a productivity growth problem, but
probably not
• No doubt that Europe has the low hours disease
• But reforms are on the way, and Europe’s health will
improve
7
European Productivity
• The European Union is a good system
– Has led to high productivity
• For 40 years prior to World War II, European productivity
53% of U.S. level
• Since 1990 about 90% of U.S. level
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Hours per Week per Person 16-64
Year
U.S.
Spain
France
Germany
1985
97
65
75
1995
100
66
71
76
2005
100
87
69
74
9
When Did the Sickness Develop?
• Europe didn’t have the low hours disease in the early 1970s
– Then 23.8 hours per person per week
– Now European hours 18.3
• U.S. hours increased from 23.5 to 25.4 in this period
because of 1986 Tax Reforms
10
What Caused the Sickness in Europe?
•
Western Europe increased marginal effective tax rate
from 40% to 60%
•
U.S. kept its tax rate at 40%
A 60% tax rate means on margin if someone works more
and produces 100€ worth of output, get to keep 40€
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U.K. Is Not That Sick
• U.K. market hours only fell from 25 per working-age
person per week in early 1970s to 23.3 today
• But …
12
The British Are Not European
13
What about Iceland?
• Tax system
– Flat rate individual income tax rate, 36%
– Consumption tax rate, 35%
• Value-added tax rate between 14% and 24.5%
• Part of property tax
• Most of excise duties
– Relatively modest payroll tax rate, 6%
14
Iceland: Predicted vs. Actual Labor Supply
• Average hours worked per person 1996-2005
– Predicted: 24.3
– Actual: 26
• Inconsistencies in measurement
– Foreign workers
– Number of part-time workers
– Size of underground economy bigger in U.S. and Europe
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Is Scandinavia a Problem for the Theory?
• Discrepancy for Scandinavia is not a measurement issue
– With simple theory aggregate hours under predicted by 2045 percent
• But this theory abstracts from
– Other factors that affect work incentives
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Features of Scandinavian Welfare States
• Subsidized day care conditional on working
• Subsidized elderly care
• Some government employment not employment
– e.g., those in training programs
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Findings
• Public expenditures on home good important for
explaining labor supply in market and at home
• Accounting for public provision of day care and elderly
care in Scandinavia closes half of gap in predicted
market work
• Sweden, after its long secular decline relative to other
advanced industrial countries, beginning in 1995 has
been reforming, has become more prosperous
Ragan (2005), Stockholm School of Economics
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What Is the Cure? Tax Rate Cuts
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What about Side Effects of Tax Cut?
• Won’t this reduce revenues that are needed to
finance social programs?
• The answer is …
20
Answer
• No
• Why: Revenue will not fall
21
Iceland: Corporate Tax Rate Down, Revenue Relative to GDP Up
1.6
1.5
%
Corporate Tax Rate
(right scale)
55
50
1.4
45
1.3
40
1.2
35
1.1
1
0.9
Corporate Taxes
as % of GDP
(left scale)
%
30
25
20
0.8
15
1985 1990
1995
2000 2003
Source: Iceland Ministry of Finance
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Cutting Taxes and Preserving the Welfare State
• Shift to some mandatory saving for retirement and
nonextraordinary medical expenditures
• Avoid throwing away output
– France 25%
– Iceland 10%
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Europe Will Cut Tax Rates and Will Boom
• Europe has no choice except to reform
• There will be healthy growth in Western Europe
– with 20% increase in output in 5 years
– and a catch-up to the United States
• Process already started
24
Spain Is Leading the Way
• Spain cut tax rates in 1998 and made other labor
market reforms
• Let’s see how Spain has been doing
25
Dramatic Improvement in Hours
Weekly Hours Worked
22
Germany
20
Spain
18
France
16
14
1985
1990
1995
2000
2005
Source: OECD
26
Why Isn’t This Cure Widely Known?
Some History
• Macroeconomists found market hours respond
strongly to incentives
• Microeconomists argued otherwise
27
Who is Right Matters for Evaluating Tax Policies
• Public finance people sided with macroeconomists
– Martin Feldstein and Glen Hubbard (former
chairmen of the Council of Economic Advisors) in
mid-1980s
• But were ignored
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Congress Sided with Labor Economists
• U.S. Congress ruled that its budget office must assume
the effect of tax rates on hours is zero
• Congress likes to tax and spend
• Congress does not like to impose dead-weight losses
• Dead-weight loss big if macroeconomists right, small if
labor economists right
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We Now Know So Much More
• We know theory predicts economic fluctuations of the
nature observed if and only if this labor response is high
(Kydland-Prescott Nobel Prize paper)
30
A Puzzle
• Microeconomists looking at individual behavior were
finding one thing
• Macroeconomists looking at aggregate behavior
were finding something different
• Why weren’t the two findings consistent?
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Theory to the Rescue
• Microeconomists assumed that people varied the length
of the workweek and not the number of weeks worked
over the lifetime
• Europeans workers work 40 weeks a year while U.S.
workers work 46 weeks a year
• Europeans retire earlier than Americans
32
Model of Life Cycle Labor Supply
• There are two margins of labor supply
– Length of working life
– Hours per employed person
Rogerson and Wallenius (2007), Arizona State University
33
Taxes Reduce Both Margins
• Length of working life important margin
Hours
 = .5
 = .3
Age
34
Puzzle Resolved
• Macroeconomists permit (and the new generation of
labor economists permit) fraction of lifetime worked to
vary
• Micro and macro observations are now in conformity
• Same response for all countries (including Japan,
Australia, New Zealand, Japan, Chile, Greece and
Ireland, as well as the G7 countries)
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Welfare
•
Nonmarket time is valuable
•
Because of taxes, the value of time on margin is
higher in the business sector than in the household
sector
Welfare gains of cutting tax rates are …
36
Welfare Gains and Losses
10%
Current U.S.
0%
Iceland
-10%
Europe
-20%
0
0.1
0.2
0.3
0.4
0.5
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0.6
Tax Rates Can Be Cut Below U.S. Levels
• How: Shift from tax and transfers to retirement saving
accounts
• Over 25 countries have them
• Singapore and U.S. have health savings accounts
38
U.S. Is Shifting
• Big shift in U.S. to savings for retirement
• Even federal government has shifted
• State and local governments have begun to shift
• Like Iceland, everyone will have their savings account
39
What about Transition Costs
Of moving to a saving system?
• There are none
• Switching is a bookkeeping entry that makes some
implicit government liabilities explicit
• Honest accounting is good
• Poverty rate would be reduced
40
Conclusions
• Iceland doing well, but could be doing better
• By moving in the direction of a saving system to finance
nonextraordinary expenditures
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