On average today, the French (and other Europeans) work one-third fewer hours than do U.S. workers. You might be tempted to attribute this difference to Europeans taste for leisure or vacations. However, in the early 1970s Europeans actually worked slightly more hours than did U.S. workers. What explains this dramatic turnaround in the space of just 20 years?
Nobel Laureate Edward Prescott, professor at Arizona State University and a senior advisor of the Federal Reserve Bank of Minneapolis, has compared the experiences of the United States and Europe. Prescott attributes the decreases in hours of work in Europe to increases in the tax burden that ultimately falls on workers. Government spending and transfers play a larger role in European economies than in the United States. For example, workers in these countries pay higher taxes, but they also receive more benefits, such as health care. Transfers in European countries increased from the 1970s to the 1990s, along with tax burdens during this period. Taking into account all taxes, Prescott calculated that the effective rate of tax on labor was 40 percent in the United States, 59 percent in Germany and France, and 64 percent in Italy. Japan s tax burden was similar to the United States, and its hours of work were also similar.
Prescott notes that as our society ages and the burdens of Social Security and Medicare increase, the United States may be tempted to increase its tax rates to European levels. Indeed, to maintain the current benefits promised by these programs, the United States will need to increase tax rates substantially. If we do not make changes in the underlying programs and allow tax rates to increase, Prescott warns that we will also see sharp declines in labor supply and potential output in the United States in the future. Living standards would fall as a result.