Union Wage Setting and Capital Income Taxation in Dynamic General Equilibrium

This paper concerns the effects of capital income taxation in a dynamic general equilibrium framework with union wage setting, when households face taxes related to both labor and capital. One purpose is to characterize the general equilibrium solution. Another is to study the effects of increased capital income taxation – in terms of the responses in real wages, employment, capital stock, output and consumption – and relate these behavioral responses to the overall tax structure. We also derive a cost–benefit rule for the purpose of analyzing the welfare effects of a small shift from labor income taxation to capital income taxation.