01/02/2017
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The Parisian Tax Paradox: French fiscal policies may be good for you!

Many finance and economics commentators, especially in the United States, tend to think of France as a high tax country. This reputation is regurlarly revisitied and reinforced in articles appearing in the financial press, see for instance Bend it like Laffer  and Another Absurdity  from The Economist and Stupidier than France at CNBC . However, these articles often mask a feature of the French tax structure that is seldom mentioned outside policy circles or the academic community: the employer share of social security contributions.

Fig. 1: Employer Social Security Contributions (SSC) and Labor Tax Wedge

Fig. 1: Employer Social Security Contributions (SSC) and Labor Tax Wedge

As seen in the Fig. 1 above, while France ranks in the middle range of EU countries in labor income taxation, it has the highest share of employer contributions to social security. While the French state may be easily lampooned by cartoonists and conservative economic commentators, our work shows that in terms of "social welfare", all EU countries and the United States would benefit if they were to adopt the French tax structure. 

We obtain this result within a model of economies subject to income taxation and tax evasion. Our tax evasion analysis is however narrowly focused on firm level avoidance of the employer social security contribution. Having set up our model solution and calibration to the data of each country in our sample, we perform two policy experiments: we either (i). increase the share of employer social security contributions in the labor tax to the French level or (ii). reduce it to the lowest levels as in Denmark (Danish employer social security contributions are virtually at zero). Our findings offer a strong refrain to the narrative of high French taxes being bad for its economy or people.

To understand why the "high" French taxes are actually welfare enhacing as we find in our study, we first need to see the response to a shift of the tax burden from workers to firms i.e. higher employer contributions as in France. Our is model is however purpose built to asnwer this type of question:

Do firms increase evasion when faced with higher taxes/contributions?

Sure they do, but by surprisingly modest amounts. In Fig 2. below, we show for a sample of countries, the response of firms, through "under the table" secondary employment, as the overall labor income tax burden is shifted from workers to employers.

Fig. 2: Secondary Sector Employment & Employer SSC

Fig. 2: Secondary Sector Employment & Employer SSC

Except for Italy and France itself, shifting the burden of the labor income tax from workers to firms/employers has only modest effects on "secondary employment", i.e.. there is negligible increases in tax evasion by firms/employers. An interesting question is then what happens to overall employment. Results in our paper show that workers actually increase labor supply in our model economies: hours worked is higher for all countries in our sample that adopt the French system. We discuss in a later post the source of the gain in employment.

Are such reforms a good thing?

Surprisingly, all countries in our sample experience a welfare gain in our policy experiments with French taxes. Our welfare evaluation is based on a consumption equivalent units comparison. These are summarized in Fig. 3 below.

Fig. 3: Welfare Change from Changing Tax Structure

Fig. 3: Welfare Change from Changing Tax Structure

After accounting for responses of workers through labor supply and that of firms through investment and tax evasion, our economies still experience considerable gains in welfare. For instance, the representative Danish worker-consumer would experience a gain equivalent to 15% of their expected lifetime consumption if Denmark adopted French levels of employer social security contributions!!! The gains are large for any country in our sample with high labor income taxes and low firm social security contributions.


Gilbert Mbara, Ryszard Kokoszczynski, Joanna Tyrowicz

Striking a balance: optimal tax policy with labor market duality

We develop a dynamic general equilibrium model in which firms may evade the employer contribution component of social security taxes by offering some workers “secondary contracts”. When calibrated, the model yields estimates of secondary labor market participation consistent with empirical evidence for the EU14 countries and the US. We investigate the optimal mix of the avoidable and unavoidable components of labor taxes and analyze the fiscal and macroeconomic effects of bringing the composition to the welfare optimum. We find that partial labor tax evasion makes tax revenues more elastic, but full tax compliance need not be a welfare enhancing policy mix.