Tax Wedge and Productivity: Empirical Evidence at the Firm Level

This paper examines the impact of the tax wedge on productivity using firm-level based TFP data for several OECD countries for the period 2000–2008. The identifying assumption is that labour costs influence firm’s behaviour and its productivity, especially in sectors with relatively higher labour intensity. To address this issue, I estimate the productivity function using the Olley-Pakes approach. Then I apply the differences-in-differences approach, which exploits differential effects of the tax wedge on firms with different labour-intensity. This approach has the advantage that it is possible to control for unobserved factors that, on average, are likely to have the same effect on productivity in any sector. The results suggest that the tax wedge has a relatively negative impact on productivity, especially for small-sized firms.