35 Years of Reforms: A Panel Analysis of the Incidence of, and Employee and Employer Responses to, Social Security Contributions in the UK

Abstract

We exploit variation in National Insurance contributions (NICs) -the UK's system of social security contributions -and a large panel dataset to examine the effects of 35 years of employee and employer NICs reforms on labour cost (gross earnings plus employer NICs), hours of work and labour cost per hour, both immediately (0-6 months) after reforms are implemented and in the slightly longer term (12-18 months). We consider assumptions under which the estimated coefficients on net-of-marginal and net-of-average tax rates in a panel regression can be interpreted as behavioural elasticities or as reflecting incidence. We find a compensated elasticity of taxable earnings with respect to the marginal rate of employee NICs of about 0.2-0.3, operating largely through hours of work, while that with respect to the marginal rate of employer NICs is not statistically significantly different from zero. We also find that labour cost falls by a much larger amount when the average rate of employer NICs is reduced than when the average rate of employee NICs is reduced, which is consistent with the economic incidence of NICs being strongly affected by its formal legal incidence. Estimates from the hours and hourly labour cost regressions provide further support to this interpretation of the findings, and also suggest the presence of substantial income effects -though also, after 1999, a puzzling effect of average employer NICs rates on hours of work. Each of these results remains true after 12-18 months (if anything, coefficients on lagged changes in NICs rates strengthen these findings), implying that any shifting of employer NICs changes to the individual employees concerned (and vice versa for employee NICs) does not begin over this time horizon. These results are similar to those found by Lehmann et al. (2013) for France but represent an extension of that work by considering hours as well as labour cost responses and second-year as well as immediate effects.

Does Tax-Benefit Linkage Matter for the Incidence of Social Security Contributions?

“…To the best of our knowledge, the role of tax-benefit linkage has not been empirically investigated in this body of research, despite being the distinctive feature of payroll taxation. While several recent papers have found less than full pass-through of employer SSCs to workers, the proposed explanation has generally been that, depending on labor supply or demand elasticities, one could expect a wide range of pass-through estimates (Komamura and Yamada, 2004;Baicker and Chandra, 2006;Murphy, 2007;Kugler and Kugler, 2009;Korkeamäki and Uusitalo, 2009;Bennmarker et al, 2009;Cruces et al, 2010;Lehmann et al, 2013;Bozio et al, 2017;Adam et al, 2019). We show that our empirical results are difficult to rationalize using this line of argument, whereas taking into account tax-benefit linkage can explain the disparities in the pass-through estimates not only in France but also in other countries.…”

Labor Market Institutions and the Incidence of Payroll Taxation

“…For example, Gruber and Krueger (1991), Gruber (1994), Gruber (1997), Anderson and Meyer (2000), and Komamura and Yamada (2004) report a pass-through rate larger than 0.8. In contrast, relatively recent studies such as Lehmann et al (2013), Skedinger (2014), Elias (2015), Egebark and Kaunitz (2018), Adam et al (2019), andSaez et al (2019) find the pass-through rate below 0.2.…”

“…Table 1 presents the results of 22 studies on the wage effects of payroll taxation. The passthrough rate, defined as the percentage change in wages upon a 1 percentage point change in payroll tax rate, ranges from below 10% (Elias, 2015;Adam et al 2019) to above 80% (Gruber, 1994(Gruber, , 1997Anderson and Meyer, 2000;Komamura and Yamada, 2004;Baicker and Chandra, 2006;Kim and Koh, 2021). However, few studies have tried to explain this discrepancy.…”

Social security contributions distribution and economic activity

“…Adam, Phillips, and Roantree (2019) …nd evidence that employees change their working hours in response to SSCs.…”