Research seminar by Professor Jochen Hundsdoerfer

We analyze how value added taxes (VATs) affect labor market outcomes (wages, firms’ employment costs, labor intensity, employment, hours worked). While VATs are formally consumption taxes, they are levied at the firm level, which creates potential spillovers to labor markets. We hypothesize that VATs affect wages and employment through two channels: an inflation adjustment effect, where employees demand higher wages to compensate for VAT-induced price increases; and a profitability effect, where incomplete pass-through reduces firms’ net sales and profits, putting downward pressure on wages and employment. We exploit variation in VAT rates, measuring labor market outcomes at the country and firm level. We find economically significant negative effects of VAT rates on wages and employment. At the country level, a one percentage point increase in the standard VAT rate is associated with a 2.67% decline in average nominal wages. At the firm level, the same increase corresponds to a 3.60% reduction in employee costs. We find a 2.04% decline in employment at the country level for a one percentage point higher VAT rate, concentrated in women and younger workers. Our study provides the first systematic cross-country evidence on the labor market consequences of VATs.