Reconsidering the Marginal Welfare Cost of Taxation*

A model with sticky wage rates and involuntary unemployment is used to compute the marginal cost of taxation, and these estimates are compared with those obtained from the conventional price-clearing equilibrium model. Important determinants of the marginal cost estimates are the response of sticky wages to a tax increase, the elasticity of demand for labour, and the unemployment gap. By contrast, the conventional model focuses on the elasticity of labour supply. The different models have different implications for efficient tax design. However, the new model generally agrees with the conventional model regarding significant efficiency costs of higher taxation.     

Optimal nonlinear income taxation with learning-by-doing

This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of first-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates generally no longer apply. In particular, if the government cannot commit and each consumer's skill-type is revealed, it is optimal to distort the high-skill type's labour supply downwards through a positive marginal tax rate to relax an incentive-compatibility constraint. Our analysis therefore identifies a setting in which a positive marginal tax rate on the highest-skill individual can be justified, despite its depressing effect on both labour supply and wages.     

Optimal Factor Income Taxation in the Presence of Unemployment

According to conventional wisdom internationally mobile capital should not be taxed or should be taxed at a lower rate than labour. An important underlying assumption behind this view is that there are no market imperfections, in particular that labour markets clear competitively. At least for Europe, which has been suffering from high unemployment for a long time, this assumption does not seem appropriate. This paper studies the optimal factor taxation in the presence of unemployment which results from the union-firm wage bargaining both with optimal and restricted profit taxation when capital is internationally mobile and labour immobile. In setting tax rates the government is assumed to behave as a Stackelberg leader towards the private sector playing a Nash game. The main conclusion is that in the presence of unemployment, the conventional wisdom turns on its head; capital should generally be taxed at a higher rate than labour.     

TAXATION AND CENTRALISED WAGE SETTING: THE CASE OF ENDOGENOUS LABOUR SUPPLY

The implications of centralised wage setting for the relationship between taxation, wages and employment are studied allowing for endogenous adjustment in work hours. We show that centralisation promotes wage moderation, makes wages and employment less sensitive to changes in wage taxation and reduces the hours worked. With an individual supply of working hours, a wage tax can even improve employment if wage setting is centralised and marginal utility from a public good is sufficiently high. Moreover, if a profit tax is used to finance public expenditure, higher tax reduces wages and improves employment.     

Tax Base and Crowding‐in Effects of Balanced Budget Fiscal Policy

A dynamic general equilibrium business cycle model is constructed with staggered price adjustment, monopolistic wage setting and distortionary taxation. The government purchases goods, runs an unemployment benefit system and balances its budget through a proportional tax on labour income. A temporary tax‐financed increase in government expenditures can lower the tax rate through a demand‐induced widening of the tax base. It is shown analytically that this allows private consumption to rise, under realistic conditions, despite the negative wealth effect of increased fiscal spending.     

Efficiency Wages and Taxes

Various taxes influence wage and employment outcomes in efficiency wage models. These findings are extended by incorporating more comprehensive tax functions and additional tax parameters. Moreover, the importance of different effort functions is evaluated. It is shown that higher marginal tax rates, holding the level of taxes constant, reduce wages and increase employment. Higher levels of taxes on income, labour costs and value-added tend to raise unemployment.     

Unemployment, growth and taxation in industrial countries

To the layman, the upward trend in European unemployment is related to the slowdown of economic growth. We argue that the layman's view is correct. The increase in European unemployment and the slowdown in economic growth are related, because they stem from a common cause: an excessively rapid growth in the cost of labour. In Europe, labour costs have gone up for many reasons, but one is particularly easy to identify: higher taxes on labour. If wages are set by strong and decentralized trade unions, an increase in labour taxes is shifted onto higher real wages. This has two effects. First, it reduces labour demand, and thus creates unemployment. Secondly, as firms substitute capital for labour, the marginal product of capital falls; over long periods of time, this in turn diminishes the incentive to invest and to grow. The data strongly support this view. According to our estimates, the observed rise of 14 percentage points in labour tax rates between 1965 and 1995 in the EU could account for a rise in EU unemployment of roughly 4 percentage points, a reduction of the investment share of output of about 3 percentage points, and a growth slowdown of about 0.4 percentage points a year.     

A spatial model of corporate tax incidence

Using a unique, self-compiled data-set on international tax rates, we explore the link between taxes and manufacturing wages for a panel of 66 countries over 25 years. We find, controlling for other macroeconomic variables, that wages are significantly responsive to corporate taxation. Higher corporate tax rates depress wages. Using spatial modelling techniques, we also find that tax characteristics of neighbouring countries, whether geographic or economic, have a significant effect on domestic wages. We test for, and reject, spatial autocorrelation in our model using a modification of the Moran-I test statistic that accounts for country-specific fixed effects in a panel data setting. Our article fits in with the new economic geography literature as well as the urban economics literature which attempt to explain the spatial distribution of wages.     

Taxation of Mobile Factors as Insurance under Uncertainty

This paper considers the effects of the taxation of mobile factors, i.e., capital, under uncertainty. The wages earned by residents of a jurisdiction are uncertain due to random shocks. Since the uncertain wages in a jurisdiction depend on the amount of mobile capital employed in the jurisdiction, and since taxation alters the quantity of capital employed, taxation affects the riskiness of uncertain wages. In particular, the taxation of capital moderates the fluctuation of uncertain wages, thereby providing insurance. For this reason, jurisdictions use distortionary capital taxation even if lump‐sum taxation is available. In addition, this insurance effect counteracts the tendency toward too low tax rates on capital arising from tax competition, and possibly improves the efficiency of tax competition.     

Optimal unemployment insurance and redistribution

We characterize optimal income taxation and unemployment insurance in a search‐matching framework where both voluntary and involuntary unemployment are endogenous and Nash bargaining determines wages. Individuals decide whether to participate as job seekers and if so, how much search effort to exert. Unemployment insurance trades off insurance versus search and participation incentives. We also allow for different productivity types so there is a redistributive role for the income tax and show that a piecewise linear wage tax internalizes the macro effects arising from endogenous wages. Type‐specific lump‐sum taxes and transfers can then redistribute between individuals of differing skills and employment states. Our analysis embeds optimal unemployment insurance into an extensive‐margin optimal redistribution framework where transfers to the involuntarily and voluntarily unemployed can differ, and nests several standard models in the literature.     

Optimal tax progressivity in unionised labour markets: What are the driving forces?

In labour markets with collective wage bargaining higher progressivity of the labour income tax creates a trade-off. On the one hand, wages are lowered and unemployment decreases, on the other hand, the individual labour supply decision is distorted at the hours-of-work margin. The optimal level of tax progressivity within this trade-off is determined using a numerical general equilibrium model with imperfect competition on the goods market, collective wage bargaining and a labour-supply module calibrated to empirically plausible elasticity values. The model is calibrated to macroeconomic and institutional parameters of both the OECD average and a number of individual OECD countries. In most cases the optimal degree of tax progressivity is below the actual level. A decomposition approach shows that the optimal level is increased by high unemployment and by the general tax level.     

Inflation Adjustment and Labour Market Structures: Evidence from a Multi‐country Study*

The impact of labour market structures on the response of inflation to macroeconomic shocks is analysed empirically. Results based on a 20‐country panel show that if labour market coordination is high, the effect on inflation of movements in unemployment, import prices, tax rates and productivity is dampened, both on impact and dynamically. In contrast, monopoly power in labour supply, measured by the percentage unionisation of the workforce, appears to amplify the response of inflation to its reduced‐form determinants. These findings are attributed to the behaviour of wages following movements in demand‐ and supply‐side conditions.     

The Beveridge curve and labour market dynamics in Turkey

This article investigates the dynamics of unemployment and vacancy rates in Turkey during the period 1951 to 2008 by means of a Beveridge Curve (BC). The time-series analysis of unemployment and vacancies as well as two other relevant labour market variables, real wages and real labour productivity, strongly suggests inefficiency in the Turkish labour market. A stable long-run relationship between unemployment rate and vacancy rate is found for Turkey, that is, the existence of a negatively sloped BC is verified. The estimated Turkish BC reflects the structural problems and lack of flexibility in the labour market. The modified BC with real wages and labour productivity reveals that labour productivity has no significant effect on unemployment rate whereas wages have positive and significant effects on the same variable.     

Viewpoint: Innovations in the theory and practice of redistribution policy

Abstract We present a survey of key results from second‐best optimal redistribution theory and their implications for tax‐transfer policy. The core results include the Corlett‐Hague theorem, the Deaton conditions, the production‐efficiency theorem, the Atkinson‐Stiglitz theorem, and the Mirrlees‐Saez characterization of the optimal non‐linear income tax system. These have been augmented in recent years by optimal participation tax rates, the implications of involuntary unemployment, the use of unconventional instruments, such as minimum wages, in‐kind transfer, and workfare, and the optimal taxation of capital income and bequests.     

Redistribution with Unobservable Bequests: A Case for Taxing Capital Income

This paper addresses the question of the optimal taxation of labour and interest income in an overlapping generations model with two unobservable characteristics, ability and inheritance. We assume realistically that saving can only be taxed anonymously, whereas the tax on labour earnings can be individualized and made non-linear. In such a setting, we show that a withholding tax on interest income along with a non-linear tax on labour income is desirable. The role of interest income taxation is to indirectly tax inherited wealth.
JEL Classification D 63, H 2     

Employment Subsidy with Capital Mobility

Most models of tax competition assume full employment. Yet, actually one often observes that fiscal competition, particularly when it is aimed at attracting investment, is motivated by the concern of fighting unemployment and enhancing job creation. The present paper considers a multicountry model with capital mobility and unemployment. Fiscal policy has two opposing objectives: financing unemployment insurance and increasing employment. In each country there is a majority vote on this policy.
The purpose of the paper is to analyse how opening borders to capital flows modifies the median voter's choice of the employment subsidy. Assuming that capital and labour are complements, economic integration is shown to raise the employment subsidy with fixed wages. This agrees with intuition as a larger employment subsidy attracts more capital. However, when wages are set by labour unions economic integration can change the median voter's choice in either direction.     

Wage–Setting Institutions, Unemployment, and Voters' Demand for Redistribution Policy

This paper examines unemployment, wages, and voters' demand for redistribution policy under three different labour market structures: laissez–faire, wage–setting by company or industrial unions, and wage–setting by a central union. Decisions on the level of taxes and benefits are made by majority rule. Taxes, wages, and unemployment are lowest under competitive wage–setting and highest with decentralised unions. A higher degree of centralisation of union wage–setting implies lower unemployment and taxes because a fiscal externality is internalised. Under some conditions about the composition of the population, the political–economic equilibrium can further be improved upon by cooperation between the government and the central union. This seems to have happened in the Netherlands where the unions and the government agreed to cut taxes and restrain wages, which has led to the 'Dutch Miracle'.     

Labor taxation, public finance, and wage determination: evidence from OECD countries

This paper analyzes the relationship between unemployment, average effective labour tax rates and public spending in 17 OECD countries. The focus is on the degree of centralization and cooperation in wage setting. Estimation results from a dynamic time-series-cross-section model suggest that the countries where wage setting takes place at the firm level have used labour taxes less extensively in financing welfare spending, compared to countries with centralized or decentralized bargaining. This is consistent with another finding, according to which labour taxes distort the labour demand the least in the countries with firm level bargaining.     

The impact of local unemployment rates on reservation wages and the duration of search for a job.

Evidence about the relationship of local unemployment rates and individuals' reservation wages and duration of search for a job if unemployed is sparse and mixed. This study uses US data from the Panel Study of Income Dynamics (PSID) to test whether relatively high local unemployment rates reduce the reservation wages of area residents or increase the duration of search. Labour search theory provides the grounding for the sample selection corrected simultaneous equations econometric model. In neither OLS nor 2SLS results is evidence found that local unemployment rates affect either reservation wages or the duration of search. These results suggest that policies targeted at alleviating unemployment should focus on increasing the demand for labour rather than hope that such policies will be beneficial if pursued in high-unemployment areas because of their effects on labour force characteristics.     

A Search Theoretic Approach on Environmental Taxation under Productive Differentials: A Note

A considerable amount of literature argues that environmental taxation fails to create a double-dividend outcome and leads to a trade-off between pollution levels and unemployment. In this paper, a simple search and matching model of labour market is developed where workers are characterized by heterogeneous productive abilities in order as to examine the impact of a pollution tax on employment. An attempt is made in order to determine the efficient level of taxation in the short run, dropping the assumption of free-entry (zero profits) of firms.