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Tax, transfer programs explain why Western Europeans work less than Americans

Lei Fang and Fang Yang

Western Europeans work less than Americans, studies have shown. But upon closer inspection, does the result still hold if some of the time spent at home is viewed as household labor rather than purely leisure activity? In such a scenario, households produce home goods that are largely substitutes for market goods.

Our recent paper suggests that Western Europeans still work less than Americans, but after recategorizing activities in the home as “work time,” the difference is reduced. We find that, relative to Americans, Western Europeans expend fewer hours in the workplace and more in home production.

Additionally, Western Europeans also spend less on market goods—things directly consumed—as well as on goods used in home consumption.

Drawing upon a quantitative life-cycle model to help understand how behaviors respond to government policies, we find that U.S. and Western European tax and government transfer programs help explain differences in work and spending patterns.

Looking closer at European time usage, expenditures

The European countries in the study sample were Austria, France, Italy, Netherlands, Norway, Spain and the United Kingdom. Time use fell into one of three classifications—market hours, home hours and leisure.

Home hours comprise time spent on food preparation, cleaning, home and vehicle maintenance, obtaining goods and services, other care, gardening and pet care. Market hours include time spent on paid work and commuting. Leisure makes up any remaining time.

Consumption expenditures related to home production are home inputs. They encompass spending on food at home, household operations, household furnishings and equipment, utilities, housing maintenance and housing (which consists of actual rents for renters and equivalent rents for homeowners).

The remaining expenditures are directly consumed and enjoyed and are included in market expenditures. Hours are expressed as a fraction of available time. Expenditures are expressed relative to GDP per adult in the United States.

Compared with Americans, Western Europeans have fewer market hours and, conversely, more home hours (Chart 1).

Chart 1: Rising prices for variety of goods, services paces record CPI increase

Downloadable chart | Chart data

The combined working time in the market and at home in Europe is lower than that in the United States—but only by 2 percent. As a result, leisure in Europe only slightly exceeds that in the United States. We also find that a large part of the cross-country differences in market hours are among those age 60 and older. Western Europeans also spend less on market goods and home inputs (Chart 2).

Chart 2: Inflation stress is weighing on the majority of Americans' minds

Downloadable chart | Chart data

Correlations between taxes, transfers, hours and expenditures

Differences in the tax and transfer programs between the United States and Europe explain dissimilarities in hours and expenditures.

Consumption tax rates in Europe—varying from 15 percent in Spain to 24 percent in France—are much higher than the 7.5 percent rate for the United States. The European Old-Age, Survivors and Disability Insurance system features a more-generous benefit scheme, and the corresponding social security tax rates in Europe vary from 22 percent to 33 percent, compared with the 10 percent rate in the U.S. The combined consumption and social security taxes in Europe are two to three times those in the U.S.

Correlations between the country-specific hours and expenditures with taxes on consumption and social security taxes provide the basis for further comparison.

Market hours appear negatively correlated with consumption taxes and social security taxes, with correlation coefficients of -0.65 and -0.51, respectively. (A correlation coefficient indicates the degree to which changes in one variable affect another.) Home hours are positively correlated with consumption (0.54) and social security taxes (0.88). Expenditures on market goods and home inputs are negatively correlated with both types of taxes.

This suggests, for example, people spend more overall when taxes are lower. Those strong correlations also indicate that country-specific tax and transfer policies likely play an important role in allocation of time and expenditures.

To help understand this, we developed a life-cycle model to formally evaluate the quantitative effects of these policies. This type of model has been used to describe how economic behaviors such as consumption, saving and working respond to changes in the economic environment, including government policies.

Assessing what factors affect activity differences

Western Europe differs from the United States not only in consumption tax, income tax and social security systems but also in the total factor productivity—a measure of productivity—for market production in which most European countries are low.

Across the studied European countries, the life-cycle model can account for 68 to 95 percent of cross-country variations in aggregate hours and expenditures.

Decomposing the overall effects, tax and government transfer programs play an important role in generating the differences between Western Europeans and Americans. Cross-country differences in the combination of consumption, income and social security taxes account for about 45 percent of the disparity in hours between Europe and the United States and 55 percent of the difference in expenditures. Total factor productivity accounts for one-third of the differences in spending and hours in the market and at home.

In addition, differences in social security and income taxes are crucial in explaining the difference in market hours around retirement ages, while total factor productivity and consumption taxes are more important determinants of the cross-country difference in market hours for workers in their prime years, ages 25 through 59.

About the Authors

Lei Fang

Fang is a research economist and associate advisor at the Federal Reserve Bank of Atlanta.

Fang Yang

Yang is an economic policy advisor and senior economist at the Federal Reserve Bank of Dallas.

The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas, the Federal Reserve Bank of Atlanta or the Federal Reserve System.

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