Question

True or False? Draw a graph to support your answer.

When unions play a decisive role in the labor market, the dead-weight loss of payroll tax is high, and the revenue generated by the tax is small.

Answer 1

The imposition of payroll tax in the labor market basically implies that the extent or the division of the burden of the tax on both the workers/laborers and employees would generally depend on the respective elasticities of labor demand and supply. Now, if the labor union is active and influential in negotiating the minimum wage or salary of the workers or laborers with the employee management then the tax burden on the laborers/workers could be reduced in this case. In such circumstances, a relatively higher negotiating and interventional power by the labor union would ensure that the workers or laborers receive the pre-stipulated wage or salary level as determined through a formal meeting or discussion between the union leaders and the employee management, regardless of the amount of the payroll imposed by the government in the labor market. Hence, the overall or total revenue obtained by the government from the labor market would be reduced as now the laborers/workers pay less portion of the tax and the employees have to pay a relatively higher portion of the tax. Figure-1 in the attached document below illustrates the general impact of the payroll tax and the negotiating and interventional power of the labor union in the labor market. The vertical axis represents the wage rate in the market and the horizontal axis denotes the quantity of labor in the market. The labor demand and labor supply are labeled as LD and LS respectively. The equilibrium wage rate in the market is indicated as w* and the wage rate paid by the employees or firms is w(E) and the wage that the laborers or workers should have received under normal circumstances or without the labor union intervention is denoted as w(L). Now, because of wage negotiation between the union and the employee management, the actual wage received by workers/laborers is w(A). The initial total tax revenue obtained by the government without any labor union intervention in the market would have been area A+B+C and following the union wage negotiation, the subsequent tax revenue obtained by the government becomes area A+B. The deadweight loss in the market in the absence of the union intervention would be area D+E+F and after the union involvement in wage negotiation, the subsequent deadweight loss becomes area D+E. Hence, observe in figure-1 that tax revenue is decreased by the area C and the deadweight loss is also reduced by the area F.