Effect of Fringe Benefit Tax on Wages : Evidence from India

Using a new tax on fringe benefits initiated in India in 2005, this paper seeks evidence for the hypothesis that the difference in higher marginal tax rates on wages, relative to lower rates on fringe benefits, induces a reallocation of the total compensation package toward fringe benefits. Firm-level panel data on employee total compensation and wages across all industries is used to link their marginal tax rate on fringe benefits and choice of compensation. The key finding is that a tax on fringe benefits only affects the wage allocation of highly paid employees relative to employees lower on the pay scale. Using my most conservative estimate, I find that an increase in fringe-tax by 1 percentage point increases wages by one percent. Another major finding in this paper is that fringes are heterogeneous in nature and their provision can be for enhancing the productivity of an employee. In provision of such productivity enhancing fringes the firms observes a hierarchy among its employees