This project is part of a larger study and offers an overview of the relationships between incentives in tax-benefit systems, labour force participation, and the growth potential of the EU. Estonia along with seven other countries joining the EU simultaneously are in focus, with the main emphasis on Estonia as its tax reforms reduced the marginal income tax rate and increased the annual tax allowance. Labour market institutions and their development in these countries are also described as well as the effects they might have on productivity.
Employment and labour force participation rates are lower in new EU member countries
It is strongly related to the tax wedge – increase in tax wedge reduces employment rates roughly twofold, especially concerning older workers whose probability of joining the work force is also reduced with high marginal tax rates that increase the overall employment. Overall, these countries also have lower tax burden and social security contributions.
Under different circumstances, the same attempts to stimulate the labour market can lead to different results.
For example, reducing marginal tax rates on market determined wages leads to greater consumption and welfare whereas with fixed wages, better results are gained by lowering employers’ social security contributions. In Estonia’s case, better results with market determined wages speak of an important difference compared to other member states. The labour supply of low-skilled is most effectively increased by lowering the marginal income tax rate.
These eight countries show considerable differences in trade union membership rates and in social dialogue overall as well as their expenses on active labour market policies. There have been rapid decreases in labour taxes which could positively effect the growth of productivity. However, the study did not show any hint of labour market institutions playing a determining role in the growth of productivity in these countries.