Taxing people depending on their location could help boost ailing regions, experts say.
They say that taxing people less if they live in a remote location helps the local economy by preventing people leaving to find better paid employment.
It also gives them more money to spend where they live, stimulating employment.
Researchers looked at how tax reform in Norway harmonised payroll tax rates across its regions.
Before this, the government of Norway applied geographically different payroll tax rates to stimulate employment, business activity and avoid depopulation of sparsely populated areas.
The rates ranged from zero per cent in the northernmost regions to 14.1 per cent in the central areas.
However, this was abolished in 2004 to comply with EU trade regulations.
The study, published in the Journal of Public Economics, found that after the location-based tax system was abolished, regions more heavily exposed to the resulting tax hike saw a substantial decline in employment and a small decrease in wages.
Wage bargaining
University College London economics lecturer Dr Hyejin Ku said: “Our findings suggest that in countries or states where wages cannot adjust so easily, due for instance to centralised wage bargaining, place-based payroll tax incentives can indeed be an effective tool in stimulating local employment in underdeveloped regions.
“Ultimately, the effectiveness of place-based payroll tax incentives in stimulating local employment depends on how flexibly wages can adjust to a given tax change.
“In settings where rising labour costs for firms are easily shifted on to worker wages, we would expect no changes in employment levels in response to payroll tax hikes.
“However, in Norway, where trade unions have strong influence over wage bargaining, we see that it is employment levels that are most affected.”
Researchers compared changes in employment and wages between 2000-2003 and 2004-2006, before and after the abolition of the special tax system to appease EU trade regulations.
They found a 1 per cent increase in the payroll tax rate leads to a decline in wages in the local labour market of 0.32 per cent.
There was also a significant decrease in local employment in response to the payroll tax rise, a 1per cent increase reduced employment in the local labour market by 1.37 per cent.
The employment decline was primarily driven by workers moving from employment to unemployment or non-employment rather than people moving to different local labour markets.
Normal payroll taxes are imposed on employers or employees and are usually calculated as a percentage of a salary.
They are a major part of labour cost for businesses as well as the spine of financing the social insurance system and payroll taxes imposed on firms make up 15 per cent of the total tax revenue.
Income inequality
Location-based payroll taxes are popular in Sweden, Finland and Norway; countries that have noticeably lower levels on income inequality.
In the UK there are noticeable regional disparities in the labour market status of people.
For example, the employment rate among males aged 16-64 varies from 82% in the South East to 74% in the North East.
The unemployment rate among economically active males aged 16-64 was 3.65% in the South East and nearly twice as high in the North East at 6.78%.
UCL Economics professor Uta Schoenberg said: “Most countries have large and persistent geographical differences in employment and income, and a growing number of place-based policies attempt to reduce these differences through targeting underdeveloped or economically stressed regions.
“In the UK, for example, the Conservative Government has said it wants to reduce regional divisions, so this could be among the types of policies they consider for a post-Brexit Britain.”
Related – Ireland shows there is still life in the left
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