August 1999

IZA DP No. 55: Value-added Tax versus Social Security Contributions

published in: Jahrbücher für Nationalökonomie und Statistik, 1999, 219 (3/4), 308-325

In order to alleviate unemployment it is often recommended to reduce social security contributions (SSC) and to compensate for the ensuing loss in revenues by a rise in the value-added tax (VAT). Assuming unemployment to be caused by efficiency wages, it is shown that a balanced-budget shift from a payroll tax to a VAT will increase employment if the rise in the VAT does not alter consumer prices. If the effects of a shift from SSC to the VAT on the worker’s effort are neutralised, for example, by imposing a constant wedge, the employment impact will depend on the nature of the unemployment compensation system.