Tax Wedge

Hot on the heels of the European Commission's positive recommendation on Estonia joining the Euro from next year, comes another news: Estonia has been invited to join the OECD.

I'm not clear enough on what we're supposed to do in the OECD to discuss the implications, although one interesting point I've heard is that with the Euro and the OECD invite, Estonia is very nearly out of targets. There are no more obvious landmarks of Western integration that we need to strive for. The only one left is membership of the Nordic Council, which is an issue of prestige and self-perception rather than any tangible economic benefit: we're already integrated into the Scandinavian economy pretty darn well.

Here's an interesting link, though: the tax wedge in OECD countries. It's a parameter that describes how much tax a household is paying, as a percentage of income; the rules for calculating it are designed to make it both representative, and comparable between countries.

The tax wedge is the difference between the money that the household receives, and the money that the employer spends on them. OECD's calculations also include any additional money that the household might get - such as child benefits. The numbers in the link don't include Estonia yet, so I did some calculations of my own, using the stat.ee database. The latest number they had on the average salary was for Q4 2009, and it was 12 259 EEK across the country. Palk.crew.ee tells me that with all taxes, including pension contributions (which I've chosen to include), that comes out to 9692,25 net. The child benefits are 300 EEK per month, for the first two children.

The most relevant and interesting demographic in my opinion is that of the two-adult, two-child household where one adult makes 100% of the average wage, and the other makes 33% of the average wage.

Labour cost Take-home pay Tax paid (percent)
1st parent 16 476,10 9 692,25 41,17388217
2nd parent 4 871,37 3 198,44 34,34203314
1st child 300,00
2nd child 300,00

Total 21 347,47 13 490,69 36,80425596

The Estonian household has a tax wedge of 36.8%. The OECD average is 36.5%. The country with the closest tax wedge to ours is Portugal, at 37.2%.

Next, let's look at a household where both parents worked, and one of them is receiving the mother's salary - since women still earn less than men on average, we can map this to OECD's numbers for the second adult earning 67% of the average wage:

Labour cost Take-home pay Tax paid (percent)
1st parent 16 476,10 9 692,25 41,17388217
2nd parent 10 760,35 6 493,81 39,65059222
1st child 300,00
2nd child 300,00

Total 27 236,45 16 786,06 38,36914319

The Estonian household has a tax wedge of 38.4%. The OECD average is 31.3%. The country with the closest tax wedge to ours is Sweden, at 39%.

Now, let's have a look at the Estonian yuppie, living alone, holding down a good job - 167% of the average wage with no children:

Labour cost Take-home pay Tax paid (percent)
One adult 28 080,82 16 186,06 42,35902833

The Estonian household has a tax wedge of 42.4%. The OECD average is 41.1%. The country with the closest tax wedge to ours is Portugal or Norway, at 43%.

You can keep playing with the numbers to see the situation that is of most interest to you. Conclusions? Despite all the talk of Estonia's very high labour tax, it's actually about the same as the average of the world's most powerful economies. We're about at the median for OECD members, and on the lower end of the spectrum for those that are also in the EU.

These numbers don't represent the VAT paid on purchases, which in Estonia is fairly high at 20%, or the excise on things like alcohol, cigarettes and fuel. However, Estonia does not have road tax on vehicles, and property taxes are very low. There is also no inheritance tax, and for the most part, no capital gains tax on investments such as real estate that appreciates in value. (Investments in financial markets are taxed as income, 21% of the difference between purchase and sale price).

Incidentally, here's a good overview in English on how Estonia's social/unemployment benefits system works. (Some of the numbers are outdated, such as the unemployment insurance contribution, which has grown to 1.4% from the employee and 2.8% from the employer.)