Payroll Taxes vs. Wage Taxes: Non-Equivalence Results

According to conventional wisdom the total tax wedge, which is the sum of payroll and wage taxes is sufficient to specify the distortion of wage formation caused by labour taxation. This paper casts doubt on this view by providing two reasons why this irrelevance conjecture may not hold in non-competitive labour markets when factors of production are complements. It is shown that gross nominal wages will increase if a revenue-neutral restructuring of labour taxes towards higher wage taxes reduces the wage elasticity of labour demand. In addition, it turns out that, even with constant labour demand elasticity, gross nominal wages increase as a result of higher wage taxes if the trade union's bargaining power is not comprehensive.