Payroll taxes and VAT in a labor-turnover model of the ‘natural rate’

We explore the effects of the tax structure in our version of the labor-turnover model of unemployment. We show that for a closed economy, a shift to increased payroll taxation offset by a lighter VAT rate raises the natural rate of unemployment. However, for a small open economy whose interest rate is given by the world rate, the tax shift is neutral for employment. Extending the analysis to a two-country world exhibiting free international capital mobility, we show that a tax shift in either one of the countries raises the natural rate in both economies.