Evaluation of the regionally differentiated social security contribution scheme

Social security contributions through employer-paid payroll tax have been regionally differentiated in Norway since 1975. The objective of regionally differentiated social security contributions (RDSSC) is to reduce or prevent depopulation in the most sparsely populated regions of Norway by stimulating employment through reduced employment costs. The scheme is the most comprehensive regional policy measure in Norway.

Using detailed micro data on Norwegian firms and employees and state of the art empirical methods to study changes in the scheme, we find evidence that most of the tax incidence resides with the employers, implying that a change in payroll tax has relatively limited effects on wages. We find that employ-ment increases directly because of reduced wage costs, allowing firms to reduce product prices to in-crease production and gain market share. The scheme also contributes indirectly to increased employment by shifting some of the tax reduction on to workers through higher wages, thereby increasing household demand for locally produced goods and services. In addition to positive effects on employ-ment in existing firms, a descriptive analysis indicates that employment also increases through the establishment of new firms.

Overall, our estimates indicate moderate employ-ment effects. However, it is reasonable to assume that the effects of changes in payroll tax are not lin-ear. A small change could be expected to have a small or no effect, because the risk and costs associated with reallocating resources reduce firms’ incentives to change their behaviour. However, if pay-roll tax had increased from the lowest to the highest tax rate, i.e. from 0 to 14.1 per cent, we would expect substantial effects. This is supported by our calculations, which show that such a jump would in-crease the share of firms with negative operating profits considerably. This suggests that RDSSC makes an important contribution to maintaining activity and employment, especially where the rates are low or zero. Thus, we cannot conclude from our moderate estimated effects that the impact of the scheme is low. The estimates should rather be considered conservative.

We find that RDSSC does enhance beneficiaries’ competitiveness domestically, which is the intention of the scheme. Most firms receiving aid from RDSSC offer services locally, clearly limiting the potential impact on international competition and trade. The share of export-oriented firms is not significantly higher in the zones with reduced rates. Furthermore, the exporting firms in the zones with reduced rates tends to be capital-intensive, thus gaining relatively little from a tax scheme that reduces the relative cost of labour. We also argue that the scope of import competition is limited by a high level of specialisation and low intra industry trade. The evaluation also finds that the vast majority of exporting firms receive support that is under the threshold for de minimis aid and is thus not defined as anti-competitive state aid according to EU rules. We conclude that there is little evidence of RDSSC having a distortive impact on competition and trade to an extent contrary to the intent of the EEA agreement.

We put forward a clear recommendation of continuing the scheme, although we also suggest considering the possibility of allowing municipalities to choose between RDSSC and receiving the same amount of support but in the form of separate free income. We suggest that such an option be limited to municipalities in the zones with tax rates close to the highest level.

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