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samfunnsokonomisk-analyse.no f 02.03.2018 Evaluation of the regionally differentiated social security contribution in Norway Draft report xx-2018 Report no. XX-2018 fra Samfunnsøkonomisk analyse AS ISBN-number: xxx Principal: xxx Cover photo: xxx Accessibility: Public Date of completion: 2 March 2018 Authors: Andreas Benedictow, Emil Cappelen Bjøru, Vegard Salte Flatval, Marthe Norberg-Schulz, Marina Rybalka, Rolf Røtnes, Arne Stokka, Maja Tofteng Lars Vik Samfunnsøkonomisk analyse AS Borggata 2B N-0650 Oslo Org.nr.: 911 737 752 [email protected] Preface [Text] Oslo, 2 March 2018 Andreas Benedictow Project manager Samfunnsøkonomisk analyse AS IV EVALUATION OF THE REGIONALLY DIFFERENTIATED SOCIAL SECURITY CONTRIBUTION IN NORWAY | SAMFUNNSOKONOMISK-ANALYSE.NO Summary This report evaluates the scheme of regionally differentiated social security contributions (RDSSC). The Norwegian authorities notified the current scheme for the period 1 July 2014 to 31 December 2020 to EFTA Surveillance Authority (ESA) in 2014. As part of the notification, the Norwegian authorities committed to evaluate the scheme, in accordance with ESA’s Regional Aid Guidelines (RAG) The Ministry of Finance has commissioned Economic Analysis Norway (Samfunnsøkonomisk analyse) and SINTEF Technology and Society to conduct the evaluation. In line with the objective of the evaluation as stated by the Ministry of Finance and the European Commis- sion Staff Working Document, Common methodology for State aid evaluations, the evaluation has tested and analysed whether the RDSSC 1) is aimed at a well-defined objective of common interest, 2) is designed to deliver the objective of common interest, 3) is appropriate and correctly proportioned to achieve these targets and 4) has a distortive impact on competition and trade. 1) Is RDSSC aimed at a well-defined objective of common interest? RDSSC is the single most comprehensive regional policy measure in Norway and has been part of a broad regional policy since the introduction in 1975. The policy finds legitimacy through broad popular and political support. The objective of RDSSC is to reduce or prevent depopulation in the most sparsely populated regions in Norway by stimulating employment. The Norwegian economy is characterized by low labour mobility and a national collective wage bargaining system, the latter leading to a relatively high degree of wage equalization for equal work between geo- graphical regions. As a result, wages will not perfectly reflect the scarcity of production factors. In remote areas with small labour markets and/or a one-sided industrial base, this could typically result in higher wages and lower employment than what would have been provided by perfect competition, see ch. 2. Under such circumstances, subsidizing wages to offset the gap between tariff and market wages could offset high labour costs in rural areas. When the RDSSC was introduced the differentiation of tax rates was justified by a reduction in employment in primary industries in rural areas. Combined with low labour mobility between regions and nationally de- termined wages, this could create “hidden” unemployment. This may still be the case, but the argumentation for stimulating rural employment has changed over the years. Today the main argument is the importance of stimulating rural employment to avoid depopulation, justified as a compensation for lower productivity in rural areas due to poorer infrastructure, lack of economies of scale, etc. Whether and to what extent, the objective of preventing or reducing depopulation is achieved through RDSSC, thereby depends on a positive relationship between employment and population. Population and employment are subject to a dynamic adjustment process and are jointly determined. Despite varying evi- dence from the literature, aggregated studies suggest that stimulating job creation in the eligible regions will contribute to preventing, or reducing, depopulation least populated regions of Norway, see ch. 6. EVALUATION OF THE REGIONALLY DIFFERENTIATED SOCIAL SECURITY CONTRIBUTION IN NORWAY | SAMFUNNSOKONOMISK-ANALYSE.NO V The objective of RDSSC is politically determined. This contrasts with many other schemes, like e.g. Skatte- FUNN, which was introduced to mitigate a market failure. On the contrary, RDSSC takes on a societal cost in order to achieve a political goal. This does not undermine the legitimacy of RDSSC, although the aca- demic justification is weaker. Nevertheless, the objective of the scheme of reducing or preventing depopulation in the most sparsely populated regions in Norway is clear and easily understood, is sought accomplished through theoretically convincing means and have broad and long standing political support. We therefore conclude that RDSSC addresses a well-defined objective of common interest. 2) Is the RDSSC designed to deliver the objective of common interest? The question to be asked here is whether the scheme have direct and/or indirect effects on the beneficiar- ies, i.e. does it reduce or prevent depopulation in the eligible regions? Employment may be increased directly by RDSSC reducing labor costs, allowing companies to reduce product prices to increase production and gain market shares. RDSSC may also contribute to increased employment indirectly, if part of a tax reduction is shifted to workers through higher wages, which in turn leads to increased demand, activity and employment in the economy, see ch. 3. It is the direct effect that explicitly justifies the choice of RDSSC as a policy instrument. The indirect effect might as well, and maybe more effectively, be achieved by other means, addressing worker or household income directly. In ch. 5, we utilise detailed micro data to study three large reforms of the scheme that have taken place during our data period 1996-2014:1 • In 2000 several municipalities were placed in another zone. We study the municipalities that got a lower payroll tax rate • The 2004-reform resulted in an increase of the tax rates in zones 2-4. The new rates were applied to the wage costs above a threshold • The 2007-reform reversed changes in 2004, introduced two new zones and, most importantly, changed the determination of the payroll tax rate from the employees’ place of residence to the location of the enterprise. 1 The sector limitations introduced in 2014 is not assessed due to lack of data after 2014. However, the relevance of this particular assessment is significantly devalued as the sector limitations are removed in 2018. VI EVALUATION OF THE REGIONALLY DIFFERENTIATED SOCIAL SECURITY CONTRIBUTION IN NORWAY | SAMFUNNSOKONOMISK-ANALYSE.NO Overall, find that the direct employment effects are moderate. Moreover, only a modest share of the burden of payroll taxation is shifted on to workers, and a correspondingly large part remains with the employers. This implies that the the indirect income effects also are modest, see ch. 5. The magnitude of wage shifting varies among zones, indicating that an even smaller share is shifted on to workers in the more rural zones. Furthermore, we find evidence of an asymmetry, as adjustments depends on the sign of the shift: The shift on to workers is lower in the case of an increase in the payroll tax rate than in the case of a decrease, reflecting that it is harder to adjust nominal wages downward than vice versa. 3) Is RDSSC appropriate and correctly proportioned to achieve these targets? We interpret this as an assessment of whether the objective could be reached in a more effective way by other means. To this end, it is useful to keep in mind what would have happened without the scheme and what alternative schemes are available or feasible. First, we find RDSSC contributing to reduce or prevent depopulation in the eligible regions. It follows directly from the results discussed above that repealing the regional differentiation of the social security contribu- tions within a tax neutral framework would have resulted in lower employment and settlement in the eligible regions and higher employment and settlement in zone 1. However, alternative schemes may also achieve similar results. In chapter 7 we saw that RDSSC in mon- etary terms by far is the most important scheme within the portfolio of rural and regional development policies. Moving all regional support from RDSSC to other schemes would therefore radically change all of them. This rise a serious question about appropriateness. Normally there would be a decreasing return of public schemes. If a scheme increases a lot in size, there is reason to assume that there will be very little effect of “the last million”. Thus, alternatives to RDSSC should preferably be a mix of other schemes to enhance employment and settlement in the eligible regions. For instance, one could increase capital and innovation support in eligible regions to promote employment. Innovation Norway and the Research Council have several such schemes readily available. Evaluations indicate that such schemes affect employment similarly to RDSSC. However, these schemes are much smaller in scope, and we do not know whether the effects will prevail if they are inflated. This would particularly be the case in Zone 5, where abolishing RDSSC will increase the social security contributions the most and where alternative schemes have to increase relatively much to achieve the same effect. Our assessment is that there is little to gain of reorganizing in this way. It may also be an alternative to increase income support to households directly as Norway

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