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Do payroll and income tax create different incentives? Is there any difference at all economically speaking? I suppose different tax deductions and tax rates may or may not apply. If so, what deductions, rates. Are there any books/research on the topic?

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Just to add a basic point not mentioned in other answers. Payroll taxes relate specifically to circumstances involving employers and employees. Income taxes apply to income from employment, but also to income from other sources which (depending on a country's tax rules) may include self-employment, pensions, savings and investments, property rents, etc.

This makes a significant difference to the incentive effects of the two types of tax. In particular, a payroll tax can create an incentive for workers to become self-employed and/or for their 'employers' to encourage them to do so. As a consequence it makes it important for the authorities to define clearly the criteria under which a worker is deemed to be an employee or self-employed (in the UK for example the criteria are as outlined here).

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Payroll taxes tend to have specific benefits accruing to the workers who pay them, and thus also benefit employers via impacts on labour supply. For example, there is a difference between taking a percentage from wages and having zero additional/marginal benefit to a worker (the case of income tax), as compared to taking the same percentage from wages and these amounts accruing to a personal account in a mandatory pooled pension managed by the government.

Thus, even if it increases the cost of hiring someone for a given (hourly equivalent) wage, the aspect of specific benefits accruing to a specific worker will positively impact the ability to attract and retain talent.

In the case of income taxes, the amount paid in taxes has no relation to benefits accruing to the workers who pay them, and hence there is no effect which would positively impact labour supply or demand in relation to an increase in income taxes (ignoring that it enables to fund activities which the market may underprovide).

The above refers to the benefits side of the question, considering that the question pertains to incentives. The cost side of the question is extremely easy to calculate (ignoring questions of whether employer or employee ultimately face more of the cost), being some specific percentage of the paycheque. It is not implied that the overall cost of the mandatory pension amounts, employment insurance, injury insurance or others are, therefore, worth more or less to the employee than an equivalent cash amount, just for the fact of noting that there is a positive incentive involved.

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Concering the actual 'tax tariff', there is a huge difference between those two. Income taxation usually feature lots of deductions and a progressive tariff, while deductions for payroll taxes are very limited. Beyond, payroll taxes are often defined by a fixed proportion, possibly with some maximum amount, implying an overall regressive distributional impact. A good overview on income taxes are provided in the regular. OECD Taxing Wages publications.

To add to nathanwww's Answer: If payroll taxes are associated with higher pension claims in the future, individuals might rather be willing to pay them. Whether everybody does so (i.e. whether everybody has this foresight) is in my view at least debatable. Beyond, if we talk about contributions to public health insurance, payroll taxes work more like an ordinary income tax. Unlike old-age pensions, the benefit I receive from the health insurance is not related to my payments.

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  • $\begingroup$ It would be helpful to add a link to the OECD publications you mention. $\endgroup$ – Adam Bailey Mar 23 '18 at 9:29
  • $\begingroup$ I definitely agree that a contribution to public health insurance is more like an ordinary income tax. $\endgroup$ – nathanwww Mar 27 '18 at 20:34

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