Governments with higher taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es generally tout that they provide more services as an explanation, and while that is often true, the cost of these services can be more than half of an average worker’s salary, and for most, at least a third of their salary.
Individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es, payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. es, and consumption taxes like value-added taxes (VAT) make up a large portion of many countries’ tax revenue. These taxes combined make up the tax burden on labor both by taxing wages directly and through the tax burden on wages used for consumption. This so-called tax burden on labor reflects the difference between an employer’s total cost of an employee and the employee’s net disposable income.
Payroll taxes are typically flat-rate taxes levied on wages and are in addition to the taxes on income. In most OECD countries, both the employer and the employee pay payroll taxes. These taxes usually fund specific social programs, such as unemployment insurance, health insurance, and old age insurance. Although payroll taxes are typically split between workers and their employers, economists generally agree that both sides of the payroll tax ultimately fall on workers.
In 2021, single, average-wage workers paid about one-third of their wages in taxes. In most Organisation for Economic Cooperation and Development (OECD) countries, families had smaller tax burdens than single workers without children earning the same income, but how much less varied. Accounting for consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es reveals higher tax wedgeA tax wedge is the difference between total labor costs to the employer and the corresponding net take-home pay of the employee. It is also an economic term that refers to the economic inefficiency resulting from taxes. s than when just accounting for income and payroll taxes.
Changes to income tax systems directly impact the tax burden on labor: Some individual countries have made substantial changes to their income and payroll taxes in the last two decades. Hungary, the OECD country with the highest tax burden on labor in 2000, has had the most notable decrease in its tax wedge, from 54.7 percent to 43.2 percent in 2021. This is partially due to the introduction of a flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. on income, which lowered the income tax burden relative to total labor costs. Additionally, Hungary reduced its payroll taxes relative to total labor costs. Denmark, Sweden, and Lithuania have also lowered their tax burden on labor substantially, with a reduction between 6 and 8.1 percentage points each.
Europe specifically: Although the tax wedge in Europe is generally high, there is a relatively wide range. The following map illustrates how European countries differ in their tax burden on labor.
Belgium has the highest tax burden on labor, at 52.6 percent (also the highest of all OECD countries), followed by Germany and Austria, at 48.1 percent and 47.8, respectively. Meanwhile, Switzerland had the lowest tax burden, at 22.8 percent.
It’s important to note that all European countries provide some targeted tax relief for families with children, typically through lower income taxes. In Germany, a single worker earning the nation’s average wage faces a tax wedge of 48.1 percent. A family with two children and one earner adult would face a tax burden of 32.7 percent. Mexico is the only country in the OECD that does not tax families at a lower rate than single workers (at the average wage).
To make the taxation of labor more efficient, policymakers should understand the inputs into the tax wedge, and taxpayers should understand how their tax burden funds government services. This will be particularly important as policymakers explore ways to encourage a robust economic recovery.