If taxation reduces the amount of hours worked, why does Scandinavia—which has some of the world’s highest tax rates—have labor force participation (LFP) rates similar to the U.S? This is the question addressed by Richard Rogerson in the NBER working paper âTaxation and market work: Is Scandinavia an outlier?â?
The study looks at three groups of countries: the U.S., the EU (Belgium, France, Germany and Italy), and Scandinavia (Denmark, Finland, Norway, and Sweden). Europeans and Scandinavians work approximately 1500 hours per employed person per year compared to the American figure of about 1850. In the year 2000, the employment to population ratio in Scandinavia is approximately 0.70, which is the same as in the U.S. Europe has an employment to population ratio of only 0.60 in 2000. We can see Scandinavia’s similarity to the U.S. workforce occurs mostly on the extensive margin. Yet, Scandinavia has the highest tax rates while the United States has the lowest. How can this be explained if taxes provide a disincentive to work?
Rogerson uses OECD and GGDC (Gronigen Growth and Development Center) data and claims that where the government revenue is spent can explain the differential. Government spending is divided into four categories as shown below.
|Lump-sum transfer||Education, health care|
|Wasteful spending||Military, unnecessary public employment|
|Subsidy to leisure||UI, disability, SS|
|Subsidy to work||Child care for working mothers.|
Rogerson contends that the EU has more government spending in the ‘subsidy to leisure’ category while Scandinavia spends more on ‘subsidy to work’ programs. The paper states that Scandinavia spends 8% of government spending on child and elderly care compared to only 2% in Europe. Further, government employment is highest in Scandinavia (i.e.: 15% in the U.S., 18% in Europe, and 28% in Scandinavia). Of course, government spending on employing individuals will increase the labor participation rates. Increased taxes decrease the incentive to work, but increased spending on programs which decrease the cost of going to work will increase labor force participation.
Rogerson then creates a model where households gain utility from consumption, leisure, and family services (e.g.: child care). In the model, taxes due decrease work incentives, but programs which decrease the price of child care increase the labor supply curve. The paper then argues that the differential in service employment explains the overall employment differential because the service sector is a proxy for the amount of child care. More and less expensive child care services make it easier for parents to enter the labor force.
This argument is very interesting and believable, but the evidence given is weak. The fact that Scandinavia has a higher service sector LFP rate does not necessarily mean that more child care is being given since the service sector includes everyone from economists, lawyers, technology consultants, fast food workers as well as child care specialists. More convincing evidence would include empirical data which showed that after a government increased child and elderly care spending, labor force participation also rose. Still, it seems obvious to Public Economists that Ricardian Equivalence will not hold in reality; where the government spends its money has significant effects on all markets.