tend to hire from unemployment and earn large rents on their workers. At the same time, high-productivity firms can employ more workers as they not only hire from unemployment, but they can also poach workers from low-productivity firms. Poached workers can get a larger share of the surplus or rents as they can use their previous job as an outside option in wage negotiations.

The model highlights that a payroll tax cut increases overall employment and wages just like in the standard framework. Importantly, however, the impact of the policy is heterogeneous across firms. Low-productivity firms, which tend to hire from unemployment, benefit disproportionately from the policy as unemployed workers have limited bargaining power. At the same time, high-quality firms poach more of their workers from other firms, which means that workers are able to claim more of the surplus from the tax cut. Thus, the model suggests that employment effects are concentrated among low-productivity firms, while wage effects are concentrated among high-productivity firms.

We examine the empirical relevance of these predictions by studying the impact of an age-specific payroll tax cut in Hungary. In 2013 the monthly social security contribution decreased by HUF 14,500 ($66) for all over-55 private sector employees.<sup>3</sup> This led to a 5.3% decrease in the labor cost for an average over-55 private sector employee.

Using rich administrative data, we estimate the impact of the policy in a difference-indifferences framework, comparing men above the age cutoff to men just below it.<sup>4</sup> We find a large increase in employment in response to the policy. In response to the 5.3% decrease in labor costs, employment of the treated workers increased by 1.6%, implying a labor demand elasticity of -0.30 (s.e. 0.03). This increase in employment mainly came from nonemployment and inactivity. The change in self-employment and public sector employment was limited, reflecting that these workers were ineligible for the payroll tax cut.

In line with the prediction of our illustrative model, we also find substantial heterogeneity across firm types. For a variety of measures of firm quality, the employment-increasing effect of the policy comes from low-quality firms and low-quality jobs, while the employment of older workers in high-quality firms is unchanged. The differential response to the policy by firm type cannot be explained by the lower relative value of the tax cut at high-quality 3The average monthly net wage (wage net of employer payroll tax) was HUF 230,700 ($1,045) in Hungary in 2013 (Hungarian Central Statistical Office, 2022), so the tax cut is about 6.3% of the average wage in 2013. A tax cut of equivalent size in the U.S. context would be $3500 per year based on the average salary in 2022 (US Bureau of Labor Statistics, 2022).

> 4We focus on men in the main analysis as for women there was another policy change instituted in 2011 that made it easier to retire earlier than the normal retirement age. That reform could potentially affect women’s post-policy employment decisions. Therefore, we have a clearer empirical design by focusing on men. Nevertheless, we also analyze the change in labor market outcomes for women separately and show that the labor market consequences of the tax policy were very similar for them.

2