Macroeconomic Effects of Reducing Labour Tax in the Euro Area. A - - PowerPoint PPT Presentation

Macroeconomic Effects of Reducing Labour Tax in the Euro Area. A Structural Model-Based Approach

(12th Dynare Conference, Rome 2016) Pascal Jacquinot1 Matija Lozej 2 Massimiliano Pisani3

1European Central Bank 2Central Bank of Ireland 3Banca d’Italia PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 1 / 26

Disclaimer

The views presented here are the views of the authors and do not necessarily reflect the views of their respective institutions, or of the Eurosystem. Results are preliminary.

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Introduction

Motivation

”...there is leeway to achieve a more growth-friendly composition of fiscal policies. As a start, it should be possible to lower the tax burden in a budget-neutral way.” Mario Draghi

(From Unemployment in the euro area, Speech by Mario Draghi, President of the ECB, Annual central bank symposium in Jackson Hole, 22 August 2014)

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Introduction

Motivation

It would be desirable to have tools that enables the analysis of fiscal policies on (un)employment in a monetary union. No micro-founded involuntary unemployment in the baseline EAGLE No public sector production or public sector employment ⇒ No ability to analyse: Effects of fiscal policies in a setting with frictional labour market:

Tax or spending changes Changes in public sector employment or compensation Feedback effects from unemployment on government budget

Effects of labour mobility between sectors Interaction of fiscal policies with labour market frictions

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Introduction

What is new

To address the above issues, we introduce:

1 Frictional labour market with unemployment 2 Combine labour market frictions with taxation 3 Add the public sector with non-negligible employment 4 Directed search to account for links between private and public

sectors through the labour market Note: Links between private and public-sector labour markets have been investigated empirically (e.g., Lane and Perotti, 2003; Lamo et al., 2013a, 2013b, etc.) and in structural models (Quadrini and Trigari, 2007; St¨ ahler and Thomas, 2013; Afonso and Gomes, 2014, etc.)

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Introduction

Afonso and Gomes (2010)

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Frictional labour market with taxation

Setup

Basic model A continuum of labour firms post vacancies, sell labour services to intermediate goods firms at competitive prices New matches become productive immediately, break-ups occur in the beginning of the period, newly unemployed search within the period and, if matched, become productive immediately Labour firms bargain with households to determine wages and hours Unemployment benefits are distributed by the government Labour taxes are paid by labour firms Full model Government sets wages and employment (vacancies) unilaterally in the public sector Public sector can have a wage premium Unemployed at the beginning of the period can direct their search to private or public sector

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Frictional labour market with taxation Matching

Matching I

Matching function Ms

t gives the number of matches in sector s,

where s ∈ {P, G}, with P denoting private and G public sector (there is no G-sector in the basic model) The number of vacancies in a sector is vacs

t , uns t is the number of

searching workers in a sector Parameter φs

mat is the efficiency of the matching process and µs mat

determines the elasticity Ms

t = φs matuns µs

mat

t

vacs 1−µs

mat

t

,

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Frictional labour market with taxation Matching

Matching II

The probability for a worker to find a job in sector s, ps,W , is: ps,W

t

= Ms

t /uns t = φs mat

vacs

t

uns

t

1−µs

mat

, and the probability for a firm in sector s to find a worker, ps,F is: ps,F

t

= Ms

t /vacs t = φs mat

vacs

t

uns

t

−µs

mat

.

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Frictional labour market with taxation Matching

Value functions of a worker

A worker can be either employed or unemployed, in which case he/she searches for a job. Value functions are defined per worker and immediately after matching has been completed. Value of being employed E s

t = (1 − τ wh t

)ws

t hs t − χ

λt hs 1+ζ

t

1 + ζ + + β λt+1 λt

• δs

x(1 − ps,W t+1 )Us t+1 + (1 − δs x(1 − ps,W t+1 ))E s t+1

• Value of being unemployed (uben denotes unemployment benefits)

Us

t = uben,t + β λt+1

λt

• ps,W

t+1 E s t+1 + (1 − ps,W t+1 )Us t+1

• PJ, ML, MP (ECB, CBIE, BdI)

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Frictional labour market with taxation Matching

Value functions of a firm

Each labour firm sells labour services to the intermediate goods firm at the price xt, pays a wage ws

t , labour taxes τ wf t

, and pays a per-period cost of having a vacancy open ψ. A hired worker works hs

t hours, which are

transformed into labour services: ys,h

t

= hs αH

t

, where αH < 1. Value of having a worker Js

t = xths αH t

− (1 + τ wf

t

)ws

t hs t + β λt+1

λt (1 − δx)

• Js

t+1

• Value of having a vacancy

V s

t = −ψ + ps,F t

Js

t + β λt+1

λt

• (1 − ps,F

t

)V s

t+1

• PJ, ML, MP (ECB, CBIE, BdI)

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Frictional labour market with taxation Matching

Free entry

Firms will enter (= post vacancies) as long as the value of having a vacancy > 0. In equilibrium, this will stop when V s

t = 0. This implies:

ψ = ps,F

t

Js,t This equation determines the number of vacancies posted. Note that in the public sector, value functions are not required (but they do exist and are analogous to those in the private sector) as long as government sets wages and determines the number of vacancies.

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Frictional labour market with taxation Wages and hours in the private sector

Wages and hours in the private sector

Wages are determined using Nash bargaining implicitly by: η(1 − τ wh

t

)JP,t = (1 − η)(1 + τ wf

t

) (EP,t − UP,t) Hours in the private sector are determined as: αHxthP, αH−1

t

= χhP ζ

t

(1 + τ wf

t

) λt(1 − τ wh

t

)

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Public sector Public sector employment and wages

Public sector employment and wages

Government sets public sector vacancies as: vacG

t = (1 − ρvac)vacG + ρvacvacG t−1 + εt,vac

Public sector wages, wG, are set by the government at a premium, pr,

• ver what labour firms charge to intermediate goods firms in the

private sector in the steady state, x: wG,t = prtx Hours in the public sector are determined as: αHxhG, αH−1

t

= χhG ζ

t

(1 + τ wf

t

) λt(1 − τ wh

t

)

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Labour market linkages

Directed search

Searching workers can decide in which sector they wish to search In equilibrium, the value of searching has to be the same in both sectors Workers take into account that by switching sectors they can get either employed in that sector or unemployed (1 − pG,W

t

)UG

t + pG,W t

E G

t = (1 − pP,W t

)UP

t + pP,W t

E P

t

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Calibration

Calibration

We set pG,F = pP,F = pP,W = 0.7, h = 1, unemployment, public-sector employment share, and wage premium to obtain: Parameter Home REA US RW Matching efficiency, private, φP

mat

0.7 0.7 0.7 0.7 Matching efficiency, public, φG

mat

0.441 0.441 0.525 0.489 Vacancy posting cost, ψ 0.12 0.12 0.55 0.55 Break-up rate, private, δP

x

0.052 0.049 0.043 0.040 Disutility of labour, χ 2.246 2.245 2.777 2.717 Job finding prob. in pub. s., pP,W 0.07 0.07 0.17 0.12 Matching elasticity, private, µP

mat

0.5 0.5 0.5 0.5 Matching elasticity, public, µG

mat

0.2 0.2 0.2 0.2 Replacement ratio, rr 0.5 0.5 0.2 0.2 Labour supply elasticity, ζ 0.5 0.5 0.5 0.5 Public sector wage premium 3% 3% 3% 5% Public sector empl. share 12.8% 18.5% 17% 15% Unemployment rate 0.08 0.08 0.06 0.06

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Fiscal policies and the labour market

Fiscal policies and the labour market

The following fiscal policy measures are considered:

1 Permanent reduction in labour taxes payable by households

... in Home

... in Basic model ... in Full model

2 Permanent reduction in labour taxes payable by firms

... in Home

... in Basic model ... in Full model

3 All shocks are standardised to 1 p.p. GDP ex-ante, amounting

to approx. 1.8 p.p. change in the tax rates

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Fiscal policies and the labour market Permanent reduction in labour taxes payable by Home households

Permanent reduction in labour taxes payable by Home households, labour responses in Home

5 10 15 20 25 30 35 40 −2 −1 Labor tax rate paid by households p.p. 5 10 15 20 25 30 35 40 −0.5 0.5 Hours worked % 5 10 15 20 25 30 35 40 0.5 1 Employed p.p. 5 10 15 20 25 30 35 40 2 4 Matching % 5 10 15 20 25 30 35 40 −1 −0.5 Unemployed p.p. 5 10 15 20 25 30 35 40 5 Probability of finding a job p.p. 5 10 15 20 25 30 35 40 −4 −2 Probability of filling a vacancy p.p. 5 10 15 20 25 30 35 40 −1 −0.5 Real wage % Basic Full PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 18 / 26

Fiscal policies and the labour market Permanent reduction in labour taxes payable by Home households

Permanent reduction in labour taxes payable by Home households, macroeconomic responses in Home

5 10 15 20 25 30 35 40 0.5 1 GDP % 5 10 15 20 25 30 35 40 1 2 Consumption % 5 10 15 20 25 30 35 40 0.5 1 Investment % 5 10 15 20 25 30 35 40 1 2 Exports % 5 10 15 20 25 30 35 40 0.5 1 Imports % 5 10 15 20 25 30 35 40 −0.1 0.1 Consumer price inflation p.p. 5 10 15 20 25 30 35 40 0.02 0.04 Monetary policy rate p.p. 5 10 15 20 25 30 35 40 0.2 0.4 Real effective exch. rate % Basic Full PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 19 / 26

Fiscal policies and the labour market Permanent reduction in labour taxes payable by Home firms

Permanent reduction in labour taxes payable by Home firms, labour responses in Home

5 10 15 20 25 30 35 40 −2 −1 Labor tax rate paid by firms p.p. 5 10 15 20 25 30 35 40 0.2 0.4 Hours worked % 5 10 15 20 25 30 35 40 0.2 0.4 Employed p.p. 5 10 15 20 25 30 35 40 1 2 Matching % 5 10 15 20 25 30 35 40 −0.4 −0.2 Unemployed p.p. 5 10 15 20 25 30 35 40 2 4 Probability of finding a job p.p. 5 10 15 20 25 30 35 40 −4 −2 Probability of filling a vacancy p.p. 5 10 15 20 25 30 35 40 1 2 Real wage % Basic Full PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 20 / 26

Fiscal policies and the labour market Permanent reduction in labour taxes payable by Home firms

Permanent reduction in labour taxes payable by Home firms, macroeconomic responses in Home

5 10 15 20 25 30 35 40 0.5 1 GDP % 5 10 15 20 25 30 35 40 0.5 1 Consumption % 5 10 15 20 25 30 35 40 0.5 1 Investment % 5 10 15 20 25 30 35 40 0.5 1 Exports % 5 10 15 20 25 30 35 40 0.5 Imports % 5 10 15 20 25 30 35 40 −0.1 0.1 Consumer price inflation p.p. 5 10 15 20 25 30 35 40 0.02 0.04 Monetary policy rate p.p. 5 10 15 20 25 30 35 40 0.2 0.4 Real effective exch. rate % Basic Full PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 21 / 26

Sensitivity

Role of public-sector wage adjustment

Key issue: spillovers and wage pressure Public-sector wages followed private-sector wages There was (almost) no reallocation between sectors!

Note: Wages have decreased after reduction of labour taxes payable by households, and increased after reduction of labour taxes payable by firms

Experiment: Adjust public-sector wages fully or only half-way and compare the effects

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Sensitivity

Permanent reduction in labour taxes payable by Home firms: Role of public-sector wages

5 10 15 20 25 30 35 40 −2 −1 Labor tax rate paid by firms p.p. 5 10 15 20 25 30 35 40 −0.5 0.5 Hours worked % 5 10 15 20 25 30 35 40 0.5 1 Employed p.p. 5 10 15 20 25 30 35 40 10 20 Matching % 5 10 15 20 25 30 35 40 −1 −0.5 Unemployed p.p. 5 10 15 20 25 30 35 40 −5 5 Probability of finding a job p.p. 5 10 15 20 25 30 35 40 −5 5 Probability of filling a vacancy p.p. 5 10 15 20 25 30 35 40 1 2 Real wage % Full wPS adj. Half wPS adj. No wPS adj. PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 23 / 26

Sensitivity

Permanent reduction in labour taxes payable by Home firms: Role of public-sector wages

5 10 15 20 25 30 35 40 0.5 1 GDP % 5 10 15 20 25 30 35 40 1 2 Consumption % 5 10 15 20 25 30 35 40 1 2 Investment % 5 10 15 20 25 30 35 40 1 2 Exports % 5 10 15 20 25 30 35 40 0.5 1 Imports % 5 10 15 20 25 30 35 40 −0.1 0.1 Consumer price inflation p.p. 5 10 15 20 25 30 35 40 0.05 0.1 Monetary policy rate p.p. 5 10 15 20 25 30 35 40 0.5 Real effective exch. rate % Full wPS adj. Half wPS adj. No wPS adj. PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 24 / 26

Sensitivity

Permanent reduction in labour taxes payable by Home firms: Role of public-sector wages

5 10 15 20 25 30 35 40 1 2 Wages (private) % 5 10 15 20 25 30 35 40 1 2 Wages (public) % 5 10 15 20 25 30 35 40 1 2 Employment (private) % 5 10 15 20 25 30 35 40 −5 5 Employment (public) % 5 10 15 20 25 30 35 40 10 20 Vacancies (private) % 5 10 15 20 25 30 35 40 −1 1 Vacancies (public) % 5 10 15 20 25 30 35 40 −20 20 Searching workers (private) % 5 10 15 20 25 30 35 40 −50 50 Searching workers (public) % Full wPS adj. Half wPS adj. No wPS adj. PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 25 / 26

Conclusions

Conclusions

Tax reductions have favourable effects on economic activity and (un)employment Positive effects both in the short-run and in the long-run Important role for labour reallocation and spillovers between sectors Labour reallocation takes time Labour mobility can amplify results by containing wage increases and improving competitiveness

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