EU report tests targeting tax cuts at low-paid

Labour shortages are one of the most pressing issues facing the European labour market, with some sectors, groups and countries more affected than others.

For example, shortages are more acute in sectors such as healthcare, construction, science or technology, and countries such as the Netherlands, Belgium, and Austria have the highest rates in the EU.

The green and digital transitions and an increasingly ageing population will further tighten this situation for both high- and low-skilled workers.

In this context, reforms of tax-and-benefit systems can improve financial incentives to work, which in turn can help tackle labour shortages by encouraging more people to take up paid work.

The findings of the commission report, which analysed a series of hypothetical reforms to the tax systems of Austria, Hungary, Italy, Belgium and Spain, suggest that targeted measures have a greater impact on labour supply (and thus on the economy) than across-the-board cuts in personal income tax.

The effect on labour market participation is four times as large for reforms targeted at low earners than for general cuts in personal income tax.

This is because reducing personal income tax for low-income earners increases their net income (what they earn after tax, social security contributions and other deductions) and thus their financial incentive to work.

For a greater impact, says the report, EU countries can introduce an earned income tax credit, a refundable amount that varies according to earnings and hours worked, up to a maximum of 80 percent of the average monthly wage. If the value of the credit exceeds the employee's income tax liability, the employee is entitled to a refund of the difference. This benefit acts as a leverage for low-income households.

In practice, the report notes, this reform achieves a greater reduction in the average tax rate paid by low-income earners — for the same budgetary cost.

The report also points out that taxing couples jointly in countries such as Belgium and Spain discourages secondary earners, who tend to be women, from working.

"A move away from the joint system could lead to an increase in secondary earners' ‒ typically women's ‒ labour supply," reads the report.

Today, almost 11 percent more men than women of working age are in employment. The gender pay gap remains at 13 percent.

The impact of this shift would be even higher for high-income households, because in a progressive tax system, the higher the income of the main earner, the higher the rate applied to the secondary earner.

The tax reform could encourage people to work and, therefore, increase tax revenues. An additional revenue that would boost the state's coffers by 0.15 percent of GDP for Belgium, and 0.24 percent for Spain to provide additional incentives for more people to work.

Reforms of tax-and-benefit systems can help to increase labour market participation, but so can the removal of entry barriers to paid work.

Providing access to affordable childcare could be one of them, bearing in mind that, for example, in the Czech Republic, net childcare costs still account for more than a third of a woman's average earnings.

"Adequate childcare supply boosts women's employment, reduces child poverty, and provides positive fiscal returns in the longer term," notes the report.