The optimal taxation of unskilled labor with job search and social assistance

In order to explore the optimal taxation of low-skilled labor, we extend the standard model of optimal nonlinear income taxation in the presence of quasi-linear preferences in leisure by allowing for involuntary unemployment, job search and an exogenous welfare benefit. In trading off low-skilled employment against work effort of higher skilled workers, the government balances distortions on the search margin with those on work effort. Higher welfare benefits typically reduce taxes paid by low-skilled workers and raise marginal tax rates throughout the skill distribution.     

Optimal age‐dependent income taxation in a dynamic extensive model: The case for negative participation tax on young people

We consider optimal age‐dependent income taxation in a dynamic model where the labor‐leisure choice is the extensive margin, each household faces idiosyncratic shocks to labor productivity and a pecuniary cost to work, and there is no insurance market against the shocks. We show that the well‐known property of the optimal participation tax rate in the static model continues to hold in our dynamic economy, that is, the participation tax rates for some income groups with low consumption are likely negative. In dynamic models, the optimal participation tax rate depends on age and on labor income. Our numerical simulations suggest that a negative participation tax should be restricted to young households.     

Intergenerational Allocation of Government Expenditures: Externalities and Optimal Taxation

This paper studies optimal capital and labor income taxes when the benefits of public goods are age‐dependent. Provided the government can impose a consumption tax, it can attain the first‐best resource allocation. This involves the uniform taxation of the cohorts' labor income and a zero capital income tax. With no consumption tax and optimally chosen government spending, labor income should be taxed nonuniformly across cohorts and the capital income tax should be nonzero. Deviations of the public goods from their respective optima create distortions. These affect the labor supply decisions of both cohorts and capital accumulation, providing a further reason to tax (or subsidize) capital income.     

DYNAMIC CONTRACTS WITH WORKER MOBILITY VIA DIRECTED ON‐THE‐JOB SEARCH

This article proposes a model with dynamic incentive contracts and on‐the‐job search in a frictional labor market. The optimal long‐term contract exhibits an increasing wage–tenure profile. With increasing wages, worker effort also increases with tenure. These two features imply that the probabilities of both voluntary and involuntary job separation decrease with both job tenure and the duration of employment. Given these results, workers experience differing labor market transitions—between employment, unemployment, and across different employers—and the equilibrium generates endogenous heterogeneity among ex ante homogeneous workers.     

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.     

Identifying Laffer Bounds: A Sufficient‐Statistics Approach with an Application to Germany

We derive a simple sufficient‐statistics test for whether a nonlinear tax‐transfer system is second‐best Pareto efficient. If it is not, then it is beyond the top of the Laffer curve and there exists a tax cut that is self‐financing. The test depends on the income distribution, extensive and intensive labor supply elasticities, and income effect parameters. A tax‐transfer system is likely to be inefficient if marginal tax rates are quickly falling in income. We apply this test to the German tax‐transfer system, and we find that the structure of effective marginal tax rates is likely to be inefficient in the region where transfers are phased out.     

Taxes,Tuition Fees,and Education for Pleasure

The fact that education provides both a productive and a consumptive (nonproductive) return has important and, in some cases, dramatic implications for optimal taxes and tuition fees. Using a simple model, we show that when the consumption share in education is endogenous and tuition fees are unconstrained, the optimal tax/fee system involves regressive income taxes and high tuition fees. A progressive labor income tax system may, on the other hand, be a second‐best response to politically constrained, low tuition fees. Finally, the existence of individuals with different abilities will also move the optimal income tax system toward progressivity.     

The Optimal Tax Treatment of Housing Capital in the Neoclassical Growth Model

Should housing capital be taxed like other forms of capital? We analyze this question within a version of the neoclassical growth model. We derive the optimal tax treatment of housing capital vis‐à‐vis business capital allowing for relatively general household preferences. In the first‐best, the tax treatment of business and housing capital should always be the same. In the second‐best, in contrast, the optimal tax treatment of housing capital depends on the elasticities of substitution between nonhousing consumption, housing, and leisure. This is because housing taxation may be used to alleviate the distorting effect of taxing labor. As a result, the optimal tax treatment of housing capital may be different from that of business capital. We complement these analytical results with a numerical analysis.     

An Efficiency Enhancing Minimum Wage

We consider an economy with a tax on all labor earnings. We discover that a slightly binding minimum wage on one sector can enhance efficiency. The minimum wage attracts high‐reservation wage workers into the minimum‐wage sector. If the labor demand curve in the free sector is quite flat, the vast majority of workers displaced by the minimum wage find employment in the free sector, raising aggregate employment. This displacement of workers by the only slightly binding minimum wage has negligible effects on efficiency. So efficiency and tax revenue rise as the minimum wage pulls labor out of untaxed leisure, where too much of the labor force is lurking, into taxed work.     

The Impact of Income Taxation on the Labor Supply of Part-time and Full-time Workers

This paper estimates the effect of income taxation on the labor supply of part-time and full-time workers in the United States. Using a model that incorporates the endogeneity of the net wage rate and the virtual income, and correcting for self-selection into part-time and full-time jobs, the results indicate that part-time workers are relatively more responsive to changes in income tax than full-time workers. Estimated wage elasticities are relatively larger for part-time than for full-time workers.The simulation results indicate that income tax has a disincentive effect on both part-time and full-time workers, with part-time and full-time workers reducing their labor supply by 0.87 and 0.58 hours, respectively, if a 5% tax is imposed. However, the percentage reduction in hours of work is very small, and a tax policy may have little effect on the labor supply of workers.The results seem to suggest that female and black part-time workers are more likely to drop out of the labor force at higher levels of income tax. It also tests the hypothesis that the labor supply behavior of parttime and full-time workers differs.The test results indicate that the determinants of the labor supply of part-time workers are different from those of full-time workers. It is noted that there is a significant difference between the labor supply of male part-time and female parttime workers, as well as between the black part-time and white part-time workers. In order to reduce voluntary unemployment in market activities among married females and blacks, the government can encourage part-time work by sponsoring legislation or instituting a scheme that will allow part-time workers to pay relatively less in payroll taxes.     

Subjective well‐being,consumption comparisons,and optimal income taxation

We introduce reference consumption into the standard utility function from optimal tax analysis. Individuals compare their consumption “narrowly” with those of the same productivity, or “broadly” with the average consumption across society. In both narrow and broad equilibria reference consumption is an increasing function of the tax parameters, so generating new theoretical results. Individual well‐being decreases with the net wage (net‐of‐tax) rate for low productivity workers under narrow (broad) comparisons, thus adjusting redistributive taxation considerations. Further, in both cases reference consumption distorts labor supply away from the social optimum level, giving a distortion‐correcting role for taxation.     

EMPLOYMENT ADJUSTMENT AND LABOR UTILIZATION

Standard models of labor adjustment assume that firms can change only the size of their workforce (the extensive margin) and not the number of hours of their existing employees (the intensive margin) in response to shocks. I propose a general equilibrium search model that allows for adjustment on both of these margins. The model includes on‐the‐job search that generates different vacancy filling and attrition rates across firms. I calibrate the model to a unique matched employer–employee panel of Danish firms and simulate two labor market policies aimed at promoting job creation: hiring subsidies and a reduction in the official workweek.     

Reexamination of Economic Growth, Tax Policy, and Distributive Politics

The paper examines the relationship between economic growth, tax policy, and distribution of capital and labor ownership in a one‐sector political‐economy model of endogenous growth with productive government spending financed by a proportional tax on capital income. The analysis shows that inequality in wealth and income can be positively or negatively related to the optimal tax rate. In either environment, higher inequality leads to a lower after‐tax return to capital, thereby reducing the economy's growth rate.     

Financing Higher Education in a Mobile World

This paper analyzes how integrated labor markets affect the financing of higher education. For this, we employ a general‐equilibrium model with overlapping generations and individuals who differ in their abilities. At the first stage, governments can choose the quality of education and the financing system. At the second stage, individuals make their education and migration decisions given the governmental framework for higher education and the mobility assumptions. In a closed economy and in the presence of imperfect credit markets, a mix of tax‐ and fee‐financing is optimal. In integrated labor markets, countries have an incentive to attract skilled workers and to free‐ride on education provided by other countries. When only skilled workers are mobile, there is a suboptimal shift from taxes to fees and the number of students is too low. When also students can migrate, there is a countervailing force such that maintaining the optimal financial mix becomes possible.     

Optimal Taxation of Risky Human Capital*

In a two‐period life‐cycle model with ex ante homogeneous households, earnings risk, and a general earnings function, we derive the optimal linear labor tax rate and optimal linear education subsidies. The optimal income tax trades off social insurance against incentives to work. Education subsidies are not used for social insurance, but they are only targeted at offsetting the distortions of the labor tax and internalizing a fiscal externality. Both optimal education subsidies and tax rates increase if labor and education are more complementary, because education subsidies indirectly lower labor tax distortions by stimulating labor supply. Optimal education subsidies (taxes) also correct non‐tax distortions arising from missing insurance markets. Education subsidies internalize a positive (negative) fiscal externality if there is underinvestment (overinvestment) in education because of risk. Education policy unambiguously allows for more social insurance if education is a risky activity. However, if education hedges against labor‐market risk, optimal tax rates could be lower than in the case without education subsidies.     

Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records

We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. We present evidence supporting three predictions of this model by analyzing bunching at kinks using Danish tax records. First, larger kinks generate larger taxable income elasticities. Second, kinks that apply to a larger group of workers generate larger elasticities. Third, the distribution of job offers is tailored to match workers' aggregate tax preferences in equilibrium. Our results suggest that macro elasticities may be substantially larger than the estimates obtained using standard microeconometric methods.     

Optimum income taxation and layoff taxes

This paper analyzes optimum income taxation in a model with endogenous job destruction that gives rise to unemployment. It is shown that optimal tax schemes comprise both payroll and layoff taxes when the state provides public unemployment insurance and aims at redistributing income. The optimal layoff tax is equal to the social cost of job destruction, which amounts to the sum of unemployment benefits (that the state pays to unemployed workers) and payroll taxes (that the state does not get when workers are unemployed).     

The evasion of fiscal and labor regulations: Firm behavior and optimal tax policy

Firms face many fiscal and labor regulations, but they may evade these legal requirements in several different ways. We develop a model that captures these two types of evasion decisions and unlike existing literature assume firms can evade labor regulations independently from income tax responsibilities. We characterize firms’ entry and evasion behavior and find that the design of the tax system can generate both positive and negative correlations between evasion decisions consistent with what is observed empirically. We then characterize optimal government policies given the firms’ decisions. We obtain intuitive optimal tax rules that highlight the trade‐offs the government faces when firms have multiple margins on which to evade.     

Optimal Age-Specific Income Taxation

This paper studies optimal earnings taxation in a three‐period life‐cycle model where taxes can be differentiated according to age. Agents choose their level of education when young and their retirement age when old. I study the problem both without and with borrowing constraints. It is shown that, without borrowing constraints, a first‐best optimum can be decentralized by setting a zero tax rate in the third period and a first‐period tax lower than the second‐period one. With borrowing constraints, the first best can no longer be achieved. The gap between the first‐ and second‐period tax rates is larger, while the third‐period tax rate is generally different from zero.