How do value added taxes affect wages and labor?

Jochen Hundsdoerfer and Maren Löwe

No 2026/1, Discussion Papers from Free University Berlin, School of Business & Economics

Abstract: We analyze how value added taxes (VATs) affect labor market outcomes (firms' employee costs, wages, hours worked, employment). While VATs are designed to tax consumption, 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 firm and country level. We find economically significant negative effects of VAT rates at the firm level on employee costs and at the country level on wages and employment. At the firm level, a one percentage point increase in the standard VAT rate corresponds to a 3.886% reduction in employee costs. At the country level, the same increase is associated with a 2.802% decline in average nominal wages. We find a 1.444% decline in employment at the country level following a one percentage point increase in the VAT rate. For working hours, the evidence is inconclusive and at most suggests a reduction. Heterogeneity analyses suggest that small firms and firms with high profit margins react stronger; among the employees, the age group 15-24 years is hit hardest. Our study provides the first systematic cross-country evidence on the labor market consequences of VATs.

Keywords: VAT; Labor Supply; Labor Demand; Wages; VAT Incidence; Inflation; Wage Bargaining (search for similar items in EconPapers)
JEL-codes: D22 D24 H22 H25 M51 (search for similar items in EconPapers)
Date: 2026
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:fubsbe:335900

DOI: 10.17169/refubium-51008

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