Imagine a worker who gets a pay rise. They should be better off. But how much better off, given that a portion of that wage increase will be offset by higher taxes? In OECD countries, this effect may be more pronounced for workers at low income levels who also become ineligible for benefits or tax reliefs. This points to a challenge at the heart of fiscal policy: how do governments support low-income households without making it less rewarding for them to climb the income ladder?
The OECD sheds light on this balancing act in its latest edition of Taxing Wages by examining the progressivity of labour taxes in OECD countries – the extent to which effective tax rates increase depending on workers’ earnings or vary according to whether they are married or have children.
This topic is at the heart of the trade-off in tax policy between equity (fairness) and efficiency (encouraging desirable economic behaviour). While progressivity is typically associated with equity, it matters for efficiency too: the way taxes and benefits change as earnings rise influences individuals’ incentive to work more hours, move into a higher-paid job or even take up employment, for instance if their spouse is already working.
Where are labour taxes most progressive?
The proportion of a worker’s gross salary that they ultimately take home is determined by a combination of personal income tax rates, tax reliefs, social security contributions and cash benefits. The OECD shows the combined effect of these elements through a standard Taxing Wages indicator for all OECD countries called the tax wedge: the difference between the total labour costs faced by an employer and the corresponding net take-home pay of an employee, expressed as a percentage of total labour costs.
The progressivity analysis examines how the tax wedge changes as earnings increase, from workers earning well below the average wage to those earning several times that amount.
Although each tax system is different, four main conclusions emerge across most OECD countries.
With a few exceptions, labour tax systems across the OECD are progressive and have become more so since 2000. But this progressivity is concentrated at low earnings levels: effective tax rates increase much more sharply below the average wage than above it. And at all earnings levels, progressivity is much more pronounced for households with children than for those without.
Increases in progressivity since 2000 have also been concentrated at lower earning levels, as labour tax burdens have declined more strongly on earnings below the average wage than above it.
Which instruments contribute to progressivity?
Personal income tax makes a major contribution to the overall progressivity of labour taxation due to tax reliefs (such as tax credits and allowances) and the increasing marginal rates built into most tax schedules. Targeted cash benefits are also a significant factor behind progressivity at lower-income levels, and they have become more widespread in OECD countries since 2000, particularly for households with children.
Social security contributions, on the other hand, tend to be slightly regressive for working households. This is because, in many countries, social security contributions are not paid on earnings above a certain threshold, which means these contributions are lower as a proportion of total labour costs for workers earning above this ceiling than for those below. However, the contribution ceiling also results in the pensions of higher earners being capped at a lower proportion of their earnings than workers earning below the threshold would receive.
What happens when earnings rise?
Consider again a lower-paid worker who gets a pay rise, takes on additional hours or moves into a better-paid job.
As their earnings increase, they may start paying more personal income tax and social security contributions. At the same time, tax credits, allowances or cash benefits for which they previously qualified may be reduced or withdrawn.
That means that part of their additional earnings can be offset by both higher taxes and lower support.
This is where the distinction between average and marginal tax burdens becomes important. A worker may face a relatively low average tax burden overall while nevertheless facing a high marginal tax wedge on the next increment of earnings.
In some circumstances, these high marginal tax wedges can create what are sometimes described as “earnings traps”, whereby additional earnings translate into a relatively small increase in disposable income.
Governments use reduced tax rates, tax credits, allowances and targeted cash benefits to support households that need it most. But if this support is withdrawn as earnings rise, policymakers face a difficult balancing act: how quickly should support be phased out without making additional work or higher earnings significantly less rewarding?
Above the average wage, the picture is different, with effective tax rates generally increasing moderately as earnings rise. This is because tax reliefs have a smaller proportional impact on the overall tax wedge, while the marginal PIT rate may increase only slightly with earnings even under a progressive tax schedule.1 Earnings traps (and the disincentives that may lurk therein) are therefore less evident in this part of the earnings distribution, although exceptions exist.
An evolving challenge for policymakers
Does this mean that labour taxes actually discourage people from seeking to earn more? Taxing Wages cannot answer that question on its own but the comprehensive, standardised data it provides on individual countries’ tax systems can identify where high marginal tax rates exist (especially at low income levels) and, more generally, help understand how incentives vary across households at different earnings levels and in different countries, thus shedding light on these fiscal trade-offs.
All the while, these questions are becoming more complex as the world of work evolves.
As the OECD’s Revenue Statistics 2025 explained, income from employed labour is still the primary source of personal income tax revenues in OECD countries, but in many countries its share is diminishing relative to income from self-employment and capital. New technologies such as AI may further affect the role of human labour in the economy.
Amid the concurrent pressures of raising revenues, supporting households in need of additional protection, and minimising economic distortions, taxes on labour and in-work benefits will need to evolve accordingly. Whatever the future holds, Taxing Wages will continue to track how countries address the trade-offs and balancing acts that lie at the heart of labour taxation.
[1] On average across OECD countries, the maximum statutory tax rate applied to wage earners is levied at 6.4 times the average wage (with half of the countries reaching this top tax rate before three times the average wage).
