London, Feb 10 (IANS): A place-based payroll tax incentive can be effective in stimulating employment in remote and underdeveloped regions, helping to address regional inequalities, new research has found.

Payroll taxes - taxes imposed on employers or employees, usually calculated as a percentage of the salaries that employers pay their staff - are a major part of labour cost for businesses.

They are the backbone of financing the social insurance system.

The study, published in the Journal of Public Economics, examined the effect of a tax reform in Norway that harmonised payroll tax rates across regions.

Prior to this, to promote economic activity in less developed and remote areas, the government of Norway applied geographically differentiated payroll tax rates -- ranging from 0 per cent in the northernmost regions to 14.1 per cent in the central areas -- to stimulate employment and business activity, and avoid depopulation of sparsely populated areas.

The geographically differentiated tax system was abolished in 2004 in compliance with EU trade regulations.

The researchers found that after the place-based tax scheme was abolished, regions more heavily exposed to the reform-induced tax hike experienced a substantial decline in employment and a modest decrease in worker wages.

"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," said first author on the study Hyejin Ku from the University College London (UCL).

"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," Ku added.

While place-based payroll taxes have not received a great deal of attention, they are popular in Finland, Norway and Sweden; countries that have noticeably lower levels of income inequality.

The researchers UCL and the University of Oslo compared changes in employment and wages before (2000-2003) and after (2004-2006) the abolition of geographically differentiated payroll taxes between commuting zones (or local labour markets).

The researchers found that a one percentage point increase in the payroll rate tax leads to a decline in wages in the local labour market of 0.32 per cent.

The researchers also found a significant decrease in local employment in response to the payroll tax hike: a one percentage point increase in the payroll tax rate reduced employment in the local labour market by 1.37%.

This is a strong response especially taking into account that only large firms -- which employ about 70 per cent of workers in the local labour market - are subject to the payroll tax increase (as the government provided a subsidy for small firms).

The employment decline was primarily driven by workers transitioning from employment to unemployment or non-employment rather than a worker moving to a different local labour market.