I'm reading a book ( Macroeconomics - Institutions, Instability and the Financial System ) and on page 62, the authors define tax wedge as the "difference between the real consumption wage and the real product wage". Should I understand this as a subtraction?

The real consumption wage is measured as $\frac{W}{P_c}$, where $W$ is the after-tax wage that employees receive, and $P_c=P(1+t_v)$ with $t_v$ being the indirect tax rate (VAT, etc).

The real product wage is the wage paid by firms to workers, and is measured by $W^{gross}/P$ where $W^{gross}=W(1+t_d)$ with $t_d$ being the direct tax rate(social securities contributions, etc).

Any help would be appreciated

  • 1
    $\begingroup$ Sounds more like a ratio than a difference. I think the sentence is the book is misleading. Other uses of tax wedge are also usually ratios. (Googling "tax wedge" finds a few.) $\endgroup$
    – Giskard
    Nov 17, 2015 at 13:21

1 Answer 1


From OECD website,

Definition of Tax wedge

Tax wedge is defined as the ratio between the amount of taxes paid by an average single worker (a single person at 100% of average earnings) without children and the corresponding total labour cost for the employer. The average tax wedge measures the extent to which tax on labour income discourages employment. This indicator is measured in percentage of labour cost.

So here, it is a ratio, but not between wages, but rather of the direct tax burden (including social security contributions), as a percentage of total labor cost (i.e of total reward of labor). But it does not include indirect taxes.

As you can see, there are different ways to define the concept (extending it to include indirect taxes makes sense -the problem would be to measure it at that level).But it appears that in general we are talking about a ratio rather than a difference.

To reconcile, it is the "difference (in absolute terms maybe) between the real consumption wage and the real product wage" as a percentage of real product wage.


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