We analyze how value added taxes (VATs) affect labor market outcomes (firms’ employee costs, wages, hours worked, employment). While VATs are designed to tax consumption, they are levied at the firm level, which creates potential spillovers to labor markets. We hypothesize that VATs affect wages and employment through two channels: an inflation adjustment effect, where employees demand higher wages to compensate for VAT-induced price increases; and a profitability effect, where incomplete pass-through reduces firms’ net sales and profits, putting downward pressure on wages and employment. We exploit variation in VAT rates, measuring labor market outcomes at the firm and country level. We find economically significant negative effects of VAT rates at the firm level on employee costs and at the country level on wages and employment. At the firm level, a one percentage point increase in the standard VAT rate corresponds to a 3.886% reduction in employee costs. At the country level, the same increase is associated with a 2.802% decline in average nominal wages. We find a 1.444% decline in employment at the country level following a one percentage point increase in the VAT rate. For working hours, the evidence is inconclusive and at most suggests a reduction. Heterogeneity analyses suggest that small firms and firms with high profit margins react stronger; among the employees, the age group 15-24 years is hit hardest. Our study provides the first systematic cross-country evidence on the labor market consequences of VATs.
