Higher Tax Rates Reduce Working Hours In OECD Countries
Differences in taxes across countries are a very important piece of the explanation for the vastly different levels of hours of market work...hours of work in the United States were roughly the same in 1956 and 2004, while hours of work in Germany decreased by about 40 percent over this same period.
Hours of market work vary widely across OECD countries. For example, in European economies such as France and Germany, hours of work are currently about one third less than in the United States. These differences are almost an order-of-magnitude larger than those associated with business cycle fluctuations in the U.S. economy. The existence of such large differences provides an excellent opportunity for us to learn about what factors have the most effect on hours of work. Moreover, understanding the factors that account for these large differences in economic outcomes is likely to have important policy implications.
In Long-Term Changes in Labor Supply and Taxes: Evidence from OECD Countries, 1956-2004 (NBER Working Paper No. 12786), co-authors Lee Ohanian, Andrea Raffo, and Richard Rogerson assess the role of labor and consumption taxes in explaining differences in hours of work across 21 OECD economies. The key finding of their paper is that differences in taxes across countries are a very important piece of the explanation for the vastly different levels of hours of market work.
The starting point for their analysis is the observation that the current differences in hours of work across countries can be traced to very different evolutions across countries over the last 50 years. Although, on average, hours of work have decreased substantially across OECD economies since 1956, what is particularly striking is the difference in the size of this decrease across economies. For example, hours of work in the United States were roughly the same in 1956 and 2004, while hours of work in Germany decreased by about 40 percent over this same period. Ohanian, Raffo and Rogerson argue that a promising approach for developing an understanding of the large current differences in hours of work across economies is to understand the factors behind these very different trend changes in hours of work across economies. In particular, they seek to understand the role that differential changes in taxes on labor and consumption have played in accounting for the differential trend changes in hours of work. Their key finding is that, for many countries, increases in taxes play a large role in explaining why hours of work have decreased over time.
The analysis in the paper is carried out in the context of the standard one-sector neoclassical growth model, which is the standard model used to interpret trend changes in economic activity. The authors first show that if one ignores taxes, this model explains virtually none of the decreases in hours of work over the period 1956-2004. But once one incorporates taxes, the model can account for the bulk of the average decrease in hours of work over this period.
Although the authors find that, on average, changes in taxes explain the changes in hours of work, there are some episodes in particular countries that require another explanation. Specifically, in some instances hours decrease by more than what the changes in taxes can explain, while in some other cases hours decrease less than would be predicted solely on the basis of changes in taxes. This work helps them to isolate those episodes that require additional attention.
While the main focus of the analysis here is on the effects of labor and consumption taxes on hours of work, the authors also consider some additional factors that are often suggested to be potentially important, such as unionization, employment protection, and generosity of unemployment insurance benefits. The authors find that once one incorporates taxes, these additional variables add little in terms of explanatory power.