Employment effects of a payroll tax cut – Evidence from a regional tax subsidy experiment

The Finnish government implemented a temporary exemption from employer social insurance contributions for the employers that are located in high unemployment areas of the Northern Finland. The payroll tax exemption was designed as an experiment that aimed to evaluate employment effects of a regional payroll tax reduction. As a result of the experiment payroll taxes were reduced by 3 – 6 percentage points for three years beginning in January 2003. In this paper we evaluate the employment and wage effects of the regionally targeted payroll tax reduction. We compare the employment and wage changes in the target region to the employment and wage changes in a control region with a similar unemployment rate and industry structure than the target region. As finding an identical control region is not possible, we adopt a matching procedure by choosing, for each firm in the target region, a matched pair from the control region. We perform propensity score matching and use the estimated propensities as balancing scores to create a control group of firms that is similar to the treatment group in all the observable pre-treatment characteristics. We then estimate the effect of the payroll tax reduction using difference-in-differences estimators, essentially comparing employment and wage changes between the matched pairs after the start of the experiment. We report results from both nearest neighbour and kernel matched comparison groups. To enhance the transparency of the evaluation we have created the matched firm pairs from the plant database of Statistics Finland and designed and published the evaluation method before any data on employment or wage outcomes were available in December 2003. We will follow the employment change of the selected firms based on annual tax reports that will be available in March 2004. Detailed information on the wage responses will be added to the report in May 2004 based on the payroll data of the members of The Confederation of Finnish Industry and Employers and The Employers Federation of the Service Industries.