Arild Hervik
Mette Rye
Møreforsking Molde
An empirical and theoretical
perspective on regional differentiated
payroll taxes in Norway
Summary
Regional differentiated payroll taxes (RDP) is a general measure that does not discriminate
between industries and firms but the relative benefit is higher in labour intensive businesses or
businesses with high wage costs. RDP shows low administrative and transaction costs, with a
stability and predictability that affects long-term economic decisions that target regional
employment and settlement. The necessity of the scheme is to contribute to a common
objective to change the strong long-term depopulation trends in peripheral regions. Sørlie
(2010) support labour opportunities as an important factor for migration and argue that
Norway has a different and more severe problem in peripheral regions than central Europe
because of a long term depopulation in peripheral regions, and highly scattered settlement
(larges area with few inhabitants) that makes it more expensive to offer a minimum level of
welfare services.
Norway has a rather coordinated centralised wage bargaining system, a high wage level and a
rather high taxation of the labour force. The lack of flexibility in the regional labour market is
one reason why the RDP measure is efficient to correct for market imperfections. Market
failure in this context is related to a lack of flexibility in the labour market and a wage level
too high to reflect local demand conditions and productivity. RDP would be an efficient
measure targeting the primary cause of the market failure, since it affects labour input as
opposed to capital, making it an appropriate scheme. RDP will generally have stronger impact
on employment than capital subsidies. The effectiveness of the measure will depend on the
industrial structure in the zones, degree of labour intensity in manufacturing and service
industries, whether labour is complementary or alternative to capital, the way the labour
market will split the tax reduction between employers and employees and the degree of labour
mobility. Empirical evidence concerning the effectiveness of the measure and the incentive
effect will be discussed in this article.
The introduction of the RDP measure in 1975 was based on a series of theoretical studies that
discussed the market failures of the regional labour markets. In the early 1980’s Norway had a
substantial focus on capital subsidies in the regional policy. However, throughout the 1980’s
the RDP measure was strengthened, while the capital subsides were reduced switching the
focus of regional measures towards targeting labour input. The introduction and expansion of
regional differentiated payroll taxes during the 1980’s had a neutral revenue effect for the
Government since they increased the payroll taxes in central areas. In 1990 the “Measure
zone” of northern Norway was established, and zero payroll tax played an important role in
the set of measures that were put up in this region. During the next period of expanding the
regional differentiated payroll taxes from 1994, Norway went through an “internal
devaluation” after an economic crisis. The payroll taxes were reduced in the peripheral and
1
central regions and the value added tax were increased giving the same tax increase as the
reduction through payroll taxes. After this second period of increase, the capital subsidies
again was reduced relatively, and the aid intensities now vary from zero up to 10.6 per cent of
employment costs in five different zones, compared to 14.1 per cent in central areas. RDP has
been the most important regional measure in Norway the last 20-30 years, and this aid has
proved to be proportionate to reduce long-term depopulation that the aid is intended to
address.
Lower payroll taxes may increase employment by the effect of substitution and the effect of
scale. First, a price reduction of a factor tends to increase the use of the less expensive
production factor and lead to the substitution of capital for labour. Secondly, reducing the tax
wedge between the workers marginal productivity and their net income tend to increase
production and employment. The strength of these effects and thus the effectiveness of the
measure, depend on the characteristics of the labour market. The extent to which the reduced
payroll taxes increase employees’ wages or lower labour costs for the employers is thus an
important question. In a simple market model, the elasticity of the supply curve will be
decisive to the spill-over effect. A relatively inelastic supply curve will lead to a higher spillover to wages. To be able to increase labour input through reduced unemployment or
underemployment level, or longer work hours, you need a higher wage increase than with an
elastic supply curve. Thus, an inelastic supply curve lowers the effect on employment. Higher
wages will lower the effect on the state revenue, but the effect on the tax wedge is lower.
However, a more elastic supply curve will have stronger effects on employment and increase
labour market efficiency through lowering the tax wedge. These effects describe a free labour
market. In a situation with collective bargaining, there might be a different picture. A possible
result is lower labour costs for the employers because of the collective wage settlement, and
this enables them to recruit high skilled workers through individual negotiations. There are
several empirical studies analysing the spill-over effect of the benefit of lower pay-roll taxes
on wages. The main conclusion is that RDP has a significant effect on employment and
reduction in labour costs, and thus proves the incentive effect and increased employment. One
study finds a long-run elasticity on regional manufacturing employment of wages
approximately equal to -1 (Johansen, 2002). Dyrstad and Johansen (2000), conclude that the
equilibrating mechanism in the regional wage formation process seems weak and that their
results imply that reduced regional payroll taxes will reduce regional wage costs, also in the
long run. However, the studies are only performed on the manufacturing sector, and we have
reasons to believe that we have significant employment effects within labour intensive service
industries too.
The total revenue effect is 13 BNOK in 2012, and 75 per cent has been attributed to the
northern parts of Norway. The service sector, including public services, is the main
beneficiary with around 77 per cent of the total revenue effect (47 per cent public services).
This is in accordance with the theoretical discussion, which expects the labour intensive
industries to benefit the most from the measure. Over the years, manufacturing account for a
decreasing share of the revenue effect. In the year 2012, manufacturing accounted for 9 per
cent of the revenue effect, while the share in 1994 was 17 per cent. Business services have
increased their share accordingly. Negative effects from aid on competition will focus large
manufacturing firms in competition with companies in Europe and this group has only 2.7 per
cent of the total revenue effect in 2012. This measure therefore will have a very small
negative effect on competition. The revenue effect will to a great extent meet the need for aid
within the local service industries with an incentive effect to increase employment.
2
In the intermediate period 2004-2007 the RDP was weakened, and compensated by public
grants of a substantial amount. The priorities of these funds were interesting to study, since
the private sector did the priorities themselves in collaboration with the public sector. As
much as 28 per cent were spent on projects that increased the skills of the workers, and
another 34 per cent concerned business development and marketing, 29 per cent different
infrastructure projects and 8 per cent research and development. However, when asked, 83 per
cent of the companies that enjoyed these grants would rather have lower payroll taxes. With
some exceptions, the measure was reintroduced in 2007. The analysis shows that projects
available to compensate for RDP will have a falling rate of return. The amount needed to
compensate for RDP will be so high that we might end up with many projects with a low
employment effect. The strength of RDP as a measure is that it will be targeted towards the
lack of employment opportunities as the driving force for depopulation.
Introduction
Employers in Norway are charged a payroll tax, which differs between five geographical
zones. The highest rate of 14.1 per cent is charged in zone 1 where around 80 per cent of the
population resides. In the other zones the rate decreases according to remoteness. In most of
south and central Norway the maximum rate is charged in more central areas, while a number
of municipalities belong to zone 2 which charge 10.6 per cent payroll tax. A few peripheral
areas in central Norway allow a rate of 6.4 per cent. In the “Measure zone” of the far north,
the businesses are not charged a payroll tax at all, while in the rest of northern Norway the tax
rate is 5.1 per cent, except the two largest cities of Bodø and Tromsø (7.9 per cent). The lower
labour costs were introduced to compensate for lasting higher operating costs due to remote
location and small markets. RDP is a general measure that does not discriminate between
industries and firms but the relative benefit is higher in labour intensive businesses or
businesses with high wage costs.
20,0 %
18,0 %
16,0 %
14,0 %
12,0 %
Zone 1
Zone 2
Zone 3
10,0 %
Zone 4
Zone 4a
8,0 %
Zone 5
6,0 %
4,0 %
2,0 %
0,0 %
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Figure 1 Development in payroll taxes for different zones from 1970-2013.
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Figure 1 shows the development of the RDP. The Norwegian Social Security system was
established in 1967 with a 7 per cent general payroll tax. In the following years the tax rate
was increased until it reached 16.7 per cent in 1973. A combination of relatively high
unemployment in the rural areas and a growing focus on regional policy with a feasible tool
(the payroll tax rate was high enough to be differentiated) paved the ground for a new
measure based on labour subsidies. As can be seen from the figure, the tax rate in zone 1 was
increased to neutralize the revenue effect of the regional differentiation. The overall reduction
of the pay-roll tax rates in 1993 is another example of a revenue neutral change of the
measure called an “internal devaluation”. The value-added tax was increased in accordance
with the pay-roll tax reduction as a general policy measure to stimulate employment. While
the selective regional measures, which are more based on capital subsidies, have experience
large budget cuts during the last decade. Following the development in employment and
wages, the effect of RDP on state revenue has increased in value. Over the years RDP has
increased its relative importance and developed to become the largest single regional policy
measure in Norway. This measure amounts to NOK 13 billion for 2012 (€1.6 billion).
The challenges related to regional development are off course complex, which means that not
one measure can solve all challenges. However, when selecting measures the information,
implementation, administration and control costs should be considered. One of the reasons for
choosing a general measure is the view that firm is better fit to make the investment decisions.
Also, the project owner will be better informed about the potential and benefit of the project
than the one selecting projects to support. This problem of asymmetric information is large
when dealing with selective innovation and R&D measures. This is linked to the problem of
rent seeking. Firms may spend considerable resources on adjusting to public measures to
obtain subsidies for non-additional activities. Rent seeking represents a welfare loss.
General measures are often costly due to volume, since it is based on general rights, as
opposed to selective measures. The introduction and the decrease in tax income, due to lower
payroll taxes, during the 1980’s were compensated by an increase in central areas. The change
in 1993 was a general reduction in payroll taxes in all regions and this tax income reduction
was compensated by an increase in value added taxes. After the war the capital subsidies was
rather high in the peripheral regions and the reduction in capital subsidies took place at the
same time as the differentiation of payroll taxes were developed. The main reason for this
change was the strong political traditions in regional policy and the challenges typical to
Norway related to a harsh climate and sparse population in certain regions. However, in 2002
the EFTA court found that the differentiated payroll tax scheme did not comply with the
State-aid rules of the EEA. The forced turn-around made a shift in balance from a focus on
general measures and labour subsidies to a stronger focus on infrastructure and different
selective measures directed towards the business sector in the period of 2004-2007.
The development of RDP has been carried by a debate on regional measures with a strong
academic focus. There has been performed a number of interesting theoretical and empirical
studies during the years which handle the different aspects of this measure. We will discuss
these studies and take a look at some of the central characteristics.
Overall theoretical problems
The characteristic of an adequate political measure is that it targets the main problem source.
When RDP was introduced, both the centralisation of settlement and regional unemployment
was seen as major problems. The source of these problems was identified as lack of jobs,
presuming a positive correlation between regional employment and settlement. The lack of
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jobs was linked to lasting higher operating cost due to remote localisation, small local markets
and higher transportation costs to larger markets. Importantly, small local markets also
reduced local supply of business services. In addition, relatively low labour mobility and
centralised wage settlements, refrained wages from reflecting local demand conditions,
causing a labour market failure. RDP target the problem sources, by compensating lasting
higher operating costs through lower labour costs that stimulate employment, in particular in
the service sectors.
The main target variable of RDP is employment. Lower payroll taxes may increase
employment by a substitution effect and an effect of scale. First, a price reduction of a factor
tends to increase the use of the less expensive production factor, which in this case leads to
the substitution of labour for capital. Secondly, the price reduction allows increased
production at the same cost. Also, reducing the tax wedge between the workers marginal
productivity and their take-home pay, tend to increase production and employment due to an
efficiency gain. The strength of these effects, and thus the effectiveness of the measure,
depends on the characteristics of the labour market. Since payroll tax is a substantial part of
the labour costs, one of the crucial questions is whether reduced payroll tax reduces labour
costs, or just shift over to wages. First, we will discuss the employment effects in a simple
model of the labour market, and then discuss how the wage formation process and system
may affect the results. The Norwegian system is a regulated market. By combining a
coordinated, centralized and local wage formation process the advantage of all alternative
models are achieved to a certain extent. The coordination of wage formation are limiting the
wage differences and lowering the wage pressure. At the same time sufficient local flexibility
might give the firms the tools to recruit, motivate and retain the workers (NOU 2013:13).
Even though Norway don’t have a labour market that works as a perfect competitive market,
the perfect competitive labour market model can give us an understanding of some main
mechanisms important to understand the efficiency problem with the labour tax wedge (NOU
1998:16).
Under certain assumptions the individual supply curves can be said to form a macro supply
curve that depend on net real wage, real alternative income and unemployment. Figure 2
illustrates two labour markets. The demand curves, E1 and E2 show a similar function in the
two markets. Employers are assumed to choose input of labour and other factors in a way that
maximizes profits for a given set of prices and technology. The demand for labour depends on
real wage costs (including payroll taxes) when labour is assumed to be the only variable factor
of production. Demand for labour increases when the wage costs are reduced, illustrated by
the demand curves E1 and E2
Labour market 2 shows a steep supply curve, while it is less steep in labour market 1. This
illustrates a more elastic supply of labour in segment 1 than in segment 2 for a given increase
in wages. This is due both to increased supply of labour within the regional market, and to
increased supply from other regions. If there is a relative wage increase compared to other
regions it is assumed an increase in commuting or people moving to the region from
neighbouring regions.
Segment 2 may characterize the situation with an inelastic supply curve, where the wages
have to increase relatively more to attract new workers or to increase the supply within the
region. The steeper curve of segment 2 can illustrate the supply of high skilled service
industry workers, with higher levels of education, often hard to attract to more rural areas.
This may also be the case in economic upswings when the labour market is tight.
5
The letter t symbolizes the tax wedge including both the payroll tax and the income tax. This
means that we hold the effect to be the same whether it is the employer or the employee that
pay the tax. The initial tax wedge is t, while f illustrates the tax wedge after a reduction in the
payroll tax. L1 is the employment effect in segment 1 while L2 is the employment effect in
segment 2 of the same labour cost reduction. L1 and L2 show that the difference in
employment effect depends on the elasticity of the supply functions (illustrated by the slope
of the supply functions). In segment 1 a more elastic supply of labour gives a higher effect on
employment. This is a situation where the benefit of a lower payroll tax is shared between the
employer aw1 and the employee lw1 and leads to both lower labour costs and an increase in
the wages. In segment 2 the benefits mainly leads to higher wages, and thus have less impact
on employment. The two markets also illustrate that the increase in labour market efficiency
caused by a lower tax wedge is higher in segment 1 than in segment 2. The area above the
supply curve, but under the demand curve, illustrates the deadweight loss and the figures
show a higher reduction in segment 1.
The model illustrates the classic theory where a reduction in payroll taxes is expected to lead
to increased employment, but where the strength of the effect depends on the elasticity of the
labour market functions. This will vary between sectors and industries. The structure of the
regional labour markets will therefore influence on the employment effects.
Figure 2 Labour markets.
This simple model illustrates aspects that would be more realistic in a game theoretic model
since 52 per cent of the Norwegian workers are organized in a countrywide trade union. The
Norwegian Federation of trade Unions (LO) is the dominating organisation, but in most
industries the wage bargaining takes place at both national and local level. The wage drift is
estimated to around 50 per cent of average wage increase (Dyrstad, Johansen, 2000). It varies
from sector to sector. In private sector the central wage contribution varies from 30-40 per
cent, while around 77-78 per cent in the public sector (NOU 2013:13), and the industries in
peripheral regions are dominated by sectors with a high degree of central wage settlement.
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The degree of organisation is low in some industries, but is quite high in manufacturing
industries and the public sector.
Among factors that affect the wage bargaining is real income, alternative income
(unemployment benefits, black markets, etc.), profits, and supply and demand of labour
(unemployment and vacancies). The weight of these factors depends on the degree of
centralised bargaining, the bargaining power and preferences and the degree of competition in
the markets, illustrated by local or international markets. If regional wage setting to a larger
degree depend on centralized negotiations and more on national than regional unemployment
rates, the equilibrating mechanism working through the regional wage formation process is
weak. Areas with a weaker development than the rest of the country may experience higher
unemployment since the wages do not respond to changes in local conditions and the wages
end up higher, and thus the employment lower, than what is clearing the local labour market.
A study made by Leif Johansen (1965) suggested that labour subsidies would be a more
efficient measure promoting regional employment than capital subsidies in an economy with
high capital mobility and low mobility in the labour market and centralized bargaining. When
the calculation price of labour is higher than the price clearing the market, due to centralized
bargaining, it is an argument for public policy stimulating employment. The thesis of Jan
Serck-Hanssen (1970) and his related publications in 1971, 1972, 1975 further supported
labour subsidies. If regional wage flexibility is high, a strong equilibrating mechanism will
dampen unfavourable effects of asymmetric shocks to regional unemployment. When the
regional wage responses to regional unemployment are small, this indicates a labour market
failure where the equilibrating mechanism working through the regional wage formation
process is weak.
A low response to changes in regional conditions give a reason to believe that the shift effect
of a pay-roll tax increase to wages is lower in a situation with centralised bargaining when the
payroll tax is regionally differentiated, since the benefit can only be accounted for in local
negotiations. This leads us to expect the shift effect to be higher if there is a common change
in the payroll tax than if it is regionally differentiated.
The main purpose of RDP is to affect the relative price of labour between regions to stimulate
employment in specific regions. Behind this strategy lies the assumption that employment
stimulates settlement. However, it can be argued that the causality is reverse; that increased
settlement will increase employment. In that case the focus should be to stimulate settlement.
However, the main problem source is still believed to be lack of jobs, especially high skilled
service sector jobs as education levels are raising. This is supported by studies like that of
Wiborg and Anvik (2000) which find that Norwegians show strong signs of local identity in
their preferences for settlement. Empirical studies made by Stambøl (1994) find a significant
correlation between employment and regional migration, and Stambøl et al. (1998) find that a
relative improvement of regional labour markets reduces migration. However, diverse labour
markets with a variety of jobs to choose from making it possible to match ones qualifications,
is part of the problem. This is supported by Stambøl (2000) that find an increasing mismatch
problem and that higher educated people are more mobile between regions. He also finds in a
study from 2002 that there is an increased centralisation of higher educated persons in
economic upswings, while central regions experience a “brain drain” in recession periods.
Sørlie (2010) also support labour opportunities as an important factor for migration and argue
that Norway has a different and more severe problem in peripheral regions than central
Europe because of a long term depopulation in peripheral regions, and highly scattered
settlement (larges area with few inhabitants) that makes it more expensive to offer a minimum
level of welfare services.
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Summing up, the structure and behaviour of the regional labour markets and the wage
formation process is vital in deciding the outcome of regionally differentiated payroll tax. The
analysis of the employment and shift effects has to depend on empirical studies. What we will
look for is studies of:




Shift effects of national and regional payroll changes on wages, since a shift of the benefit
into increased wages will reduce the effect on employment.
The importance of local conditions in the wage formation process
How the regional supply and demand curves of labour react to changes in wages and
prices which in turn often depend on how labour and other factors can be substitutes in
production.
How the RDP measure affect different industries and businesses
Empirical studies
How the RDP measure affect different industries and businesses is studied by Hervik (1997),
Hervik et al. (2001) and Rye et al. (2003), and updated now for 2012. The studies show that
most of the total revenue effect (13 BNOK in 2012) has been attributed the northern parts of
Norway, around 75 per cent (zone 4 and 5). These are areas in the north with long-lasting
depopulation problems. Figure 3 shows the distribution of revenue effects in private sector by
industries. It reflects the regional employment and wage levels, but also how the measure is
targeted. The service sector including public services is the main beneficiary with around 77
per cent of the revenue effect (47 per cent public services). This is in accordance with the
theoretical discussion, which expects the labour intensive industries to benefit the most from
the measure. Over the years, manufacturing account for a decreasing share of the revenue
effect. In the year 2012, manufacturing accounted for 17 per cent of the revenue effect in
private sector, while the share in 2000 was 23 per cent. Business services have increased their
share accordingly.
8
Figure 3 Revenue effects of RDP in private sector by Standard Industrial Classification,
(Source: Statistics Norway, adjusted figures).
Looking only at the private sector,Ошибка! Источник ссылки не найден. figure 4 shows
the revenue effect by firm size in 2012. Around 24 per cent of the revenue effect of the private
sector was attributed to large firms (251 employees or more), while about 18 per cent went to
medium sized firms and 57 per cent went to small firms (50 employees or less). 5.1 per cent
of the revenue effect in private sector was attributed to large manufacturing firms, while this
share was only 2.7 per cent of the total revenue effect. It can be seen that manufacturing and
transport and communication are the industries with the highest share of large and medium
sized firms. Local firms are classified by size according to the size of the parent company.
However; the main share of the revenue effect is attributed to medium sized and smaller
firms.
9
Figure 4 Revenue effects by Standard Industrial Classification and firm size in private sector
2012 (Source: Statistics Norway).
Tax relief directed towards specific sectors or agents normally encourage tax-avoidance
behaviour. Prior to 2007, this was regarded a minor problem for RDP since it carried a
residence principle where the taxation rates differ by the home address of the employees, and
not the location of the firm. This was at situation where the firm was the beneficiary, paying
lower payroll taxes on wages to residents within zones 2-5. However, commuting from higher
to lower zones transferred parts of the benefits to firms outside aid areas. We found that 18
per cent of the revenue effect went to firms located in zone 1 (Hervik & Rye, 2003).
However, now that the measure is administrated to be a benefit following the location of
production, the beneficiary can influence on the benefits through the way they register the
localisation of production.
Another possible “leakage” of the measure is whether lower payroll taxes influence the wage
formation process leading to increased wages through wage negotiations and thus reduce the
employment effect. The shift effect to increased wages reduce the measure to include only a
multiplier effect through a potential increase in private consumption, that will partly leak out
of the region. This shift effect has been the attention of many Norwegian empirical studies.
Stølen (1996) gives an overview of several studies in the early 1990’s, while examples of later
studies are Johansen (2002), Dyrstad and Johansen (2000), Johansen and Klette (1997) and
Østby (1995). Looking back at figure 1, the changes of the Norwegian RDP allow studies of
wage effects both at a national and a regional level reflecting partial and general changes in
the payroll tax. Since the best data is that of the manufacturing sector, most of the studies are
performed on these industries, even though the main share of the measure is attributed to the
service sectors. This is a weakness of the studies. The manufacturing industries are the wage
leaders according to the Scandinavian theory of inflation (Aukrust, 1977), and in the so-called
“front model” manufacturing starts the process of wage negotiations. Later empirical studies
10
also find that wage growth in sectors outside manufacturing are highly dependent on
manufacturing wages (Stølen, 1996).
The Norwegian studies that have considered the shift effect all find that reduced payroll taxes
will reduce wage costs in the short run. This implies a high degree of consensus what regards
the positive short run employment effect of the RDP measure. Regarding the long run effect
the result differ, especially between national and regional level studies, but also due to
differences in the specification of the models. We are first going to refer some of the studies
at a national level, before we discuss effects from differentiating the pay-roll taxes at a
regional level.
Lowering pay-roll taxes as a means to increase employment is a well-known and well-studied
policy suggestion. A uniform tax reduction is not a regional measure; however,
macroeconomic studies of uniform changes may give some information of the effect on wage
or labour cost developments. Norwegian macroeconomic studies of the average changes in the
pay-roll tax rates find that a high degree (70-80 per cent) of the tax reductions will be shifted
over to wages in the long run. Wulfsberg (1995 and 1997) finds a full shift effect on wages in
the long run, but not in the short run. Johansen and Klette (1997) find a shift effect between
60 and 100 per cent comparing firms within same industry but different regions. This is in
accordance with a study made on 16 OECD countries by Jackman et al. (1996). They find no
systematic long run impact of pay-roll taxes on labour costs but substantial temporary effects.
The macroeconomic model of Statistics Norway (MODAG), presume a full shift effect to
wages in the long run. Estimates done on this model show that an increase in pay-roll taxes
will take around ten years to shift over to lower wages (Cappelen & Stambøl, 2003). In the
meantime there are considerable cost increases in the zones. Since the macroeconomic model
is not well suited to estimate regional differentiated changes in the pay-roll tax, they do some
adjustments and find that an increase of the pay-roll tax to a common rate of 14.1 per cent will
lead to a decrease in employment by around 3.5 per cent in the northern part of Norway, and
0.5-2 per cent in the zones of mid- and southern part in the short run. The model presumes
lower wage costs in the long run as the tax increase is shifted over to lower wage raises.
However, it does not estimate the possible regional effect of people moving as the relative
wage level falls in the regions. The estimates include a full compensation in the public sector.
If the municipalities are not compensated, the employment effect is about twice as much.
Also, if there is no shift effect the employment effect is estimated to around 10 per cent, or at
least twice the size compared to a situation with a shift effect. This is the same finding as
made by Kolsrud and Nesset (1992) using the macroeconomic model of the Central Bank of
Norway. To get no shift effect one has to presume a fully flexible labour market or fully
centralised wage negotiations, which is unrealistic. The situation in the Norwegian labour
market is most likely something in between. Important to the strength of the employment
effect is the possibility to substitute labour for capital in the production. The degree of
substitution will vary between firms and industries. This can be illustrated by estimates of the
substitution elasticity which differ in different studies, and some of which are reflected in
table 1.
The national level effects are however, not fully illustrating the regional measure which is
concerned about the regional effects. A high degree of centralised bargaining will lead us to
expect that a regional lowering of payroll taxes to a less extent will shift over to wages in the
bargaining process. An important finding in this regard in the studies of Johansen (2002),
Dyrstad and Johansen, (2000) and Wulfsberg (1995) is that Norwegian regional wages are
mainly determined by countrywide factors and that the regional wage flexibility is low. The
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studies all find that the equilibrating mechanism in the Norwegian labour market is weak,
which is an argument for public policy. This reflects the tradition of centralised bargaining
which was one of the theoretical arguments for introducing the RDP.
Several studies find geographically differentiation of the payroll taxes may have significant
long run effects on the relative wage costs between regions and thus a positive effect on
employment also in the long run. Johansen (2002) finds that reduced regional payroll taxes
are almost fully transmitted into reduced regional wage cost. His preliminary results find a
long-run elasticity on regional manufacturing employment of wages approximately equal to 1. Dyrstad and Johansen (2000), conclude that the equilibrating mechanism in the regional
wage formation process seems weak and that their results imply that reduced regional payroll
taxes will reduce regional wage costs, also in the long run. However, they find that the shortrun impact of RDP is sensitive to the specification of the wage equation. Dyrstad (1992) finds
that reduced regional payroll taxes is not transmitting into increased regional wages in the
short-run, but finds a long-run elasticity of -0.3 (1 per cent reduction in regional wage cost
will increase regional wages 0.3 per cent. Like Johansen (2002) he finds long run elasticity on
regional manufacturing employment of wages approximately equal to -1. However, he finds
that a revenue neutral regional differentiation of the pay-roll tax has little effect on
employment. While Østby (1995) finds that 10 per cent reduction in pay-roll tax implies an
8.8 per cent increase in employment. Also, several of the earlier studies reported by Stølen
(1996) find long run effects:
“A favourable geographical differentiation of payroll taxes for the rural areas has obviously
been beneficial for employment in this areas as less than 20 per cent of the reduction is passed
over into higher wages in a single region.” (Stølen, 1996).
Wage bargaining in Norway takes place at both national and firm level. If the local bargaining
mechanism is dominating, reduced payroll taxes may still be shifted over to wages. The cited
studies listed in table 1 are made on data from the Norwegian manufacturing industry where
there is a high degree of centralised bargaining. One might argue that the studies cover only a
small part of the Norwegian labour market. However, there is a tradition for other sectors to
follow the wage settlement in the manufacturing sector in accordance with the Scandinavian
theory of inflation (Akrust, 1977).
12
Authors
Level
Johansen.
(2002)
Regional:
1970-92
322
municipalities
Timeseries
Dyrstad and
Johansen
(2000)
Regional:
1970-88
333
municipalities
Dyrstad
(1992)
Regional:
1970-88
333
municipalities
Wulfsberg
(1995)
National:
7000 firms
1972-88
Wulfsberg
(1997)
National:
7323 firms
1972-88
Østby (1995) Regional:
1980-88
313
municipalities
Panel data
Johansen and National,
1983-93
Klette (1997) All firms
larger than 5
employees
Relevant findings
He finds that reduced regional payroll taxes are almost fully transmitted into reduced regional wage cost and
consequently stimulate regional employment. Preliminary results show long run elasticity on regional
manufacturing employment of wages approximately equal to -1. Regional wage response to open regional
unemployment is small with a long run unemployment elasticity of pay approximately equal to -2%.
They conclude that the equilibrating mechanism in the regional wage formation process seems weak and that
their results imply that reduced regional payroll taxes will reduce regional wage costs, also in the long run.
However, they find that the short-run impact of RDP is sensitive to the specification of the wage equation.
They find that aggregate unemployment is more important than regional unemployment in shaping regional
pay, which means that unemployment affects wages through central wage settlements. The long run elasticity
with respect to regional unemployment approximates – 0.02 while it is around – 0.07 with respect to national
unemployment.
He finds that reduced regional payroll taxes is not transmitting into increased regional wages in the short-run,
but finds a long-run elasticity of –0.3 (1 per cent reduction in regional wage cost will increase regional wages
0.3 per cent. ) Estimates of the employment effect find that one per cent pay-roll tax increase will reduce
employment by 0.3 per cent in the long run. A revenue neutral regional differentiation of the pay-roll tax has
little effect on employment.
He finds a full shift effect on wages in the long run, but not in the short run. There is a weak adjustment of
regional labour market, with an insider weight of 0.05 and an elasticity of regional wages to regional
unemployment between – 0.035 and –0.020, but he finds no effect on national unemployment.
Find that an increase in pay-roll tax is borne by labour in the long run, but that the effect on wage costs are
significant in the short run. There is a small insider weight of about 5 per cent, indicating that the Norwegian
wage setting system is more centralised than for instance the UK.
He find that 10 per cent reduction i pay-roll tax implies an 8.8 per cent increase in employment. Employment
would have been .5 per cent higher without wage bargaining.
They find a shift effect between 60 and 100% comparing firms within same industry but different regions.
They find substitution elasticity between labour and capital of 0.4.
Table 1 Later econometric (multiple regression analysis) Norwegian studies related to RDP.
13
Interestingly and in contrast to the Norwegian econometric studies, Bohm and Lind (1993)
find no employment effects in their study of a Swedish temporary attempt of lower pay-roll
taxes in the region of Nordbotten in Sweden. They used a quasi-experimental evaluation
method when analysing the effects. They compared the development within the region with
the development in a control group and a control period. The reason they did not find any
employment effects in the one Swedish region receiving the measure may have several
explanations. There are differences in the extent of the measure. The Swedish measure was
limited to certain basic industries like manufacturing, mining, tourism and minor service
sectors. The Norwegian measure covered all industries including the more of labour intensive
businesses like public and private services and trade which tend to have a higher elasticity of
demand for labour. A limited measure both in time and extension may have contributed to it
being difficult to measure any effects. Even though the government announced a long lasting
measure, the firms may have believed that the reductions did not last, which also was the
case. Since they did not find a shift effect on wages, the benefit may have led to increase in
profits. In their study of the region Svappara (Bohm &, Lind, 1988) where the measure was
set to a zero pay-roll tax rate, they did find some employment effects. This may indicate a
general measure has to be strongly dimensioned to be able to measure an effect. The
evaluation methods are also different. Comparative and quasi-experimental evaluation will
always meet a challenge in estimating the contra factual situation. In our studies of
employment effects of RDP (Hervik, Ohr & Rye (2002) and Hervik & Johansen (1992)), we
find it difficult to conclude on the effects due to the contra factual problem.
The profile and the effect of compensating measures
In September 2002, the EFTA Surveillance Authority concluded that RDP did not comply
with the State-aid rules of the EEA Agreement and requested Norway to present measures to
adjust the scheme. On 25 March 2003, the Norwegian authorities notified the Authority on a
three-year transition period for the RDP in zones 3 and 4, and the introduction of a new direct
transport aid scheme. The Norwegian authorities also described the introduction of a de
minimis scheme of the original differentiation. No transition period was notified for zone 2.
For zone 5, in the northernmost part of Norway, the EFTA States decided by common accord
to allow a continuation of a zero tax rate. After the transition period is over, the cost to the
firms implies a total increase in the tax rate of up to 9 per cent of all wages except for the de
minimis support. The public sector (municipalities and counties) was compensated through
public transfers.
Even though Norway kept a large part of the original system through the de minimis rule, the
exception for the very northern part of the country and the compensation of the public sector,
there was a major change of the system. The short run effect on employment was assumed to
depend on the market power of the local firms and the success of the compensating measures.
Firms operating in international markets are often price takers, while those operating only in
local markets to a larger degree may set the prices and increase prices when costs are rising.
Empirical studies indicated a considerable negative short run effect on private sector
employment following a pay-roll tax increase without compensation.
In the transitional period of 2004-2006 when there was a progressive adjustment of the rates
of social security contributions, a new funding mechanism was introduced to compensate for
the regional effect of the increased business taxes. When the transition period was over, RDP
was reintroduced in 2007 in the least populated regions (less than 8 inhabitants per square
kilometre). In certain regions it was not fully reintroduced, and the new funding mechanism
was kept.
14
The affected regions receive their share of compensation according to the calculated increase
in costs. All regions formed a regional board consisting of representatives of the business
sector and in most cases there are representatives from the regional office of Innovation
Norway and local government. The boards allocate the funds to different regional and
business development purposes.
This caused a major change in the regional measures in Norway, from mainly focusing
general measures, to an increased focus on selective measures. These compensating funds
were as large as the total of the already existing regional development funds handled by the
institution Innovation Norway, which only administrate selective measures. In 2004 the
boards were entrusted with around €65 million, in 2005 around €100 million, with a peak in
2006 of €145 million. The funds were reduced to around €53 million in 2007, when most of
the original measure was reintroduced. In addition there was a transportation aid fund and an
infrastructure fund for high speed internet, used as compensating measures in the transitional
period.
How the boards chose to allocate these funds was interesting to study:



Would they more or less try to copy the original measure through selective compensating
measures, or did they select projects that compensated in a more general way?
What are the effects of these substantial new measures, do we find projects that stimulate
regional growth and employment?
Will there be sector projects that stimulate the weak supply of highly educated workers, in
a better way than RDP does?
Interestingly, the reports for the first years of the new funding system showed that around 50
per cent of the compensating funds were spent on selective measures, while around 40 per
cent are spent on projects that benefit a majority of the firms in the region, like infrastructure
or educational measures. This means that a bottom-up management of regional measures
chose to allocate a large share to other forms of general measures.
Our studies show a great variety of projects and differences between regions in their
priorities. Even though the majority of the projects are small, the large share of the funding
(62 per cent) went to the 10 per cent largest projects. Since the companies that carry the cost
of increased social security tax, it is interesting to know what they think of the
compensational measures. A study made on 200 projects from 2005 through Innovation
Norway, with a response rate of 48 per cent (96 projects). This study show that 1/5 of the
respondents think that the measures really compensate for the loss of the RDP measure, while
1/3 do not find it satisfying. 83 per cent of the respondents say that they would prefer the RDP
reintroduced.
15
Figure 5 Distribution of compensation for increased payroll taxes by measures.
16
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