Taxes on labour income – including social security contributions – account for around one half of total tax revenue, on average, in OECD countries. As such, it is unsurprising that these taxes can have a significant impact on employment. This report examines in detail the effects of taxation on employment, highlights the resulting policy challenges, and discusses options for responding to these challenges.

Achieving a high level of employment is generally considered desirable for a number of economic and social reasons. However, tax systems will generally act to deter employment by reducing the returns to working received by employees, and/or increasing the labour costs faced by employers. This publication examines the effects of taxation on employment, considers the resulting policy challenges, and discusses the ways governments endeavour to address these challenges.

This chapter provides a broad overview of how taxation affects employment. This analysis is then augmented in the following chapters of the report by the more detailed analysis of the effects on three groups where empirical research suggests that responses of labour supply to taxation may be relatively large: low-income workers, older workers and mobile high-skilled workers.

Chapter 1 emphasised the low employment rates amongst low-income workers compared to higher-income workers in many OECD countries.1 This difference is driven by both lower participation and greater (involuntary) unemployment than in higher-income groups. This chapter considers both factors, though the predominant focus is on the participation side, examining both the causes of the low supply of labour by low-income workers, and the ways in which OECD countries attempt to address this concern.

As illustrated in Chapter 1, employment rates of older workers are substantially lower than for younger workers. This difference is driven predominantly by the relatively low labour force participation of older workers, although unemployment is also a factor in relation to some groups of older workers. This chapter considers both factors, though it’s primarily focus is on the participation side, considering both the effect of tax on the work incentives of older workers, and possible ways of increasing these work incentives.

This chapter looks at the international dimension to the taxation of employment income, particularly in relation to high-skilled individuals. Globalisation and the growth of MNEs have, empirical evidence suggests, increased the extent to which corporate income tax rates and regimes affect the location of investment (see, for example, Altshuler et al., 2001; OECD, 2007c). But have such trends had an impact on labour markets and is a global market for “talent” developing? The attractions of the US market for skilled (English-speaking) workers has, for instance, been suggested as a possible explanation for trends in top incomes in English-speaking countries showing similar trends to the United States (albeit to a less marked degree).