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Article (05/10/2007)

Belgium's NRP - Macroeconomic effects of reducing the tax wedge on labour

Every three years, each EU Member State is required to set out its political priorities related to economic growth and job creation in a so-called National Reform Programme (NRP). The 2005-2008 programme prepared by the Belgian authorities proposes six lines of action for boosting growth and employment. For each of these lines of action, one or two quantitative objectives have been set out. In this working paper we compare the main macroeconomic objectives contained in the Belgian NRP with the results of the latest medium-term economic outlook produced by the Federal Planning Bureau. This no-policy-change scenario also serves as a baseline for analysing the effects on the main macroeconomic objectives of the government of a further reduction in social security contributions in order to ease the tax wedge on labour as foreseen in the NRP.

The medium-term economic outlook is a very detailed macroeconomic projection that covers developments by industry, evolutions in the labour market, in public fi-nances and in energy consumption and associated greenhouse gas emissions. The main objective of this projection is not to produce the forecasts that best anticipate the most likely political decisions, but rather to provide a consistent benchmark scenario under the assumption of no changes in economic and social policies. According to this scenario, compliance with the main macroeconomic objectives contained in the Belgian NRP would still require efforts in all areas and especially in the labour market.

We therefore computed the impact of a further reduction in social security contributions in order to achieve the target of lowering the fiscal and parafiscal pressure on labour by 2.2 percentage points of GDP between 2005 and 2010. This policy was simulated using the HERMES model under two different wage settings. The first modality supposes that the reduction in social security contributions has no effect on the wage bargaining process. Gross wages before indexation remain in this case identical to the baseline and as a result reductions in employers' social security contributions have full repercussion on the wage cost while a cut in employees' contributions leave the labour cost practically unchanged. The other modality assumes, on the contrary, that reductions in social security contributions do affect the wage setting according to the wage bargaining process specified in LABMOD, the FPB's labour market model: a reduction in employees' social security contributions will induce a decrease in gross wages while a reduction in employers' contributions will be partly captured by wage earners and gross wages will therefore increase. Concerning the latter, two types of policies were tested: a general reduction in employers' contributions and a reduction targeted at low wage earners.

With the modality of unchanged gross wages, both policies have a positive impact on growth and employment but the targeted reductions in employers' contributions induce the creation of more jobs and a slightly higher GDP, despite their dampening effects on labour productivity. In the other wage setting framework, the impact of the policies tends to be somewhat more favourable as the lowering of the gross wages induced by the reduction in employees' contributions dominates the increasing impact caused by the cut in employers' contributions. All in all, reducing the tax wedge undeniably boosts economic activity and increases the employment rate.

Nevertheless these policies have a negative impact on the other objectives of the NRP, notably regarding public finances and greenhouse gas emissions. The budget balance deteriorates in comparison with the reference scenario because the additional public revenues and reduced public expenditure generated by the simulated policies are insufficient to fully compensate for the initial budgetary cost. Note that the policy targeting low wage earners produces the worst outcome for the budget balance, as the substitution in favour of this category of workers tends to slow down the increase in the wage bill and, as a result, income tax revenue. Moreover, the Kyoto protocol objectives become even more difficult to attain because the higher economic growth produces a rise (although limited) in greenhouse gas emissions.

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