Tax wedges on employee earnings rose slightly in OECD countries in 2004


09/03/2005 - The tax wedge on earnings rose in more than half of the OECD's 30 member states in 2004, with more countries showing increases than decreases in the share of wage costs taken by tax and social security contributions, net of child allowances and similar benefits, according to the latest edition of the OECD's annual Taxing Wages

During 2004, 18 countries showed an increase in the tax wedge for a single person earning the average wage of a production-line employee during 2004, while 11 countries showed a reduction and one was unchanged (see Table 1). For a single parent with two children earning two-thirds of the average wage, tax wedges were higher in 15 countries, lower in 12 and unchanged in three. For a one-earner married couple with two children earning the full average wage, 17 countries took a higher tax wedge, 12 had a lower wedge and one was unchanged.

The variations in most cases amounted to only a fraction of a percentage point, but the effect on an OECD-wide basis was an increase in tax wedges of between one-tenth and three-tenths of a percentage point, depending on category. The tax wedge is the share of total labour costs taken by the state in income tax plus employer and employee social security contributions, minus any cash benefits paid.

The small overall increase, which follows a recent trend of reductions in tax wedges on earnings, was the result of a range of factors, including buoyant wage growth and the associated phenomenon fiscal drag as increased earnings pushed employees into higher tax brackets, as well as changes in tax policy. At a time when many governments are reducing taxes on corporate profits and capital, the figures serve as a reminder of the dampening effect of taxation on incentives for individuals to work and for employers to provide jobs. Data in Taxing Wages also highlighted wide variations in tax policy from one country to another.

In most countries, married employees with children enjoy tax advantages over single people on similar earnings, but their extent varies widely. Furthermore, tax systems in some countries are designed in such a way as to impose high effective marginal tax rates (the proportion of additional income paid to the government) for some workers, discouraging those affected from seeking to earn more by working harder.

For a single person with average earnings, the net tax burden (income tax and employee social security contributions, less cash benefits) was highest in Denmark at 41.2 per cent of earnings, followed by Germany and Belgium at 40.5 per cent, and lowest in Mexico (4.5 per cent) and Korea (9.3 per cent) (see Table 2). A single-earner married couple on average wages with two children, by contrast, faced a net tax burden of only 29.4 percent in Denmark, 18.1 percent in Germany and 16.4 percent in Belgium. By contrast, in Korea the advantage for a married couple in this category was only marginal, with a net tax burden of 8.4 per cent, and in Mexico it was nil.

Single-earner married couples on average wages with two children in Ireland and Luxembourg actually received more money in cash transfers from the state than they paid out in income tax and social security contributions, and in neither of these countries were higher effective marginal tax rates a disincentive to such families to seek to earn more (see Chart 1).

By contrast, the disincentive from marginal effective net tax rates was particularly high for single-earner families with two children on average wages in the United Kingdom, Australia, Canada and the United States. Due to the progressive design of tax credits and benefit systems in these countries, tax reliefs fell as income rose, increasing the marginal rate on every additional pound or dollar of earnings.

For a single employee on average production wages, tax wedges in 2004 ranged from a high of 54.2 per cent of total labour costs in Belgium and 50.7 per cent in Germany to a low of 15.4 per cent in Mexico and 16.6 per cent in Korea. This means that the costs to employers of taking on new workers in Belgium or Germany is more than twice the workers' take-home pay, while in Mexico and Korea the cost is less than one and a quarter times take-home pay. 

For single parents with two children on two thirds of average production wages, tax wedges ranged from a high of 41.8 per cent in Turkey to a low of -20.2 per cent in Ireland and -11.2 per cent in the United Kingdom, where benefits received by single parents at this income level exceeded income tax and social security contributions. The largest increase for this family type was 6.2 percentage points in Australia while the largest decline was 2.0 percentage points in Austria. For one-earner married couples with two children earning average production wages, tax wedges ranged from a low of 5.9 per cent in Ireland and 9.3 per cent in Luxembourg to a high of 42.7 per cent in Turkey.

Taxing Wages is available from the OECD's Online Bookshop and to journalists through the OECD's password-protected website or from the Media Relations Division For further information and comment, journalists are invited to contact Christopher Heady, in the OECD's Centre for Tax Policy and Analysis (tel: [33] 1 45 24 93 22).

See tables and graph.


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