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by Joni Baran, Industry Canada, December 1996
Since the early 1980s, chronic unemployment problems in Canada, as well as in most other industrialized countries, have prompted a heightened interest in the empirical research of the causes of persistent unemployment. Among the areas examined has been employer payroll taxes and their effect on job creation. Although research in this area has been relatively sparse, it has become a more popular area of study in the 1990s.
This paper is a survey of the more noteworthy analysis performed in this area with an emphasis on Canadian empirical research. The objective is to provide a single locus where much of the work relating to the impact of payroll taxes on employment can be presented and from this, to draw conclusions.
Part 1 gives a brief overview of federal payroll taxation in Canada and the perspectives of various stakeholders with respect to the impact of payroll taxes on employment. Part 2 provides an economic primer designed to familiarize the non-economist reader with the concepts and terminology referred to later in the paper.
Much of the earlier work on payroll taxes was surveyed by Bev Dahlby for the Ontario Fair Tax Commission and the Canadian Tax Foundation, by Daniel Hamermesh in his book Labor Demand and in the OECD Jobs Study publications. These surveys are summarized in Part 3 of the paper. Further empirical analyses, published since the above-mentioned literature surveys, which have focused on Canada in particular, are surveyed in Part 4. The OECD Jobs Study and a working paper commissioned by the study, as well as research done by Beach, Lin and Picot (1995); Di Matteo and Shannon (1995); Wilton and Prescott (1993); Parker (1994); and Cozier and Mang (1993) are included in the survey.
The consensus of the surveyed literature is that increases in employer payroll taxes tend to have negative short-term effects on employment. Most of the evidence, however, concludes that adverse employment effects do not persist in the long run. Additionally, most research tends to support the notion that payroll taxes levied on employers have a greater negative effect on employment than employee payroll taxes. Although there has been no empirical work which examines the employment stimulation effect of a decrease in employer payroll taxes, conventional economic theory suggests that the effects would be less than the corresponding job loss associated with a payroll tax increase.
Earnings ceilings on Unemployment Insurance (UI), now known as Employment Insurance, and the Quebec/Canada Pension Plan (Q/CPP), the federal programs funded by payroll taxes, create a situation where the marginal tax rate with respect to these payroll taxes is higher for low income earners than for high income earners. Hence, any increases in employer payroll tax rates will have more of an impact on workers whose incomes fall below the ceilings. This is somewhat troublesome given that unemployment is concentrated among low income, low skilled members of the labour force.
Employer payroll taxes are likely to affect small businesses differently than large businesses for several reasons. Payroll taxes constitute a much larger proportion of total taxes for small businesses; compliance and administrative costs are higher; smaller businesses tend to be labour intensive and to hire more low income, low skilled employees; short-run market adjustment effects can have a more onerous cash-flow impact on small businesses; and payroll taxes are profit insensitive. On the other hand, small businesses are less likely to be unionized and, therefore, are more able to pass employer payroll tax increases back to workers.
Separate from the survey of this literature, it is interesting to note that other industrialized countries, as well as some Canadian provinces, have adopted targeted payroll tax rate reductions in an attempt to mitigate any negative employment effects associated with payroll taxes.