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Do Taxes Explain European Employment? Indivisible Labor, Human Capital, Lotteries, and Savings

In: NBER Macroeconomics Annual 2006, Volume 21

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  • Lars Ljungqvist
  • Thomas J. Sargent

Abstract

Adding generous government supplied benefits to Prescott's (2002) model with employment lotteries and private consumption insurance causes employment to implode and prevents the model from matching outcomes observed in Europe. To understand the role of a 'not-so-well-known aggregation theory' that Prescott uses to rationalize the high labour supply elasticity that underlies his finding that higher taxes on labour have depressed Europe relative to the US, this paper compares aggregate outcomes for economies with two arrangements for coping with indivisible labour: (1) employment lotteries plus complete consumption insurance, and (2) individual consumption smoothing via borrowing and lending at a risk-free interest rate. The two arrangements support equivalent outcomes when human capital is not present; when it is present, allocations differ because households' reliance on personal savings in the incomplete markets model constrains the 'career choices' that are implicit in their human capital acquisition plans relative to those that can be supported by lotteries and consumption insurance in the complete markets model. Nevertheless, the responses of aggregate outcomes to changes in tax rates are quantitatively similar across the two market structures. Thus, under both aggregation theories, the high disutility that Prescott assigns to labour is an impediment to explaining European non-employment and benefits levels. Moreover, while the identities of the non-employed under Prescott's tax hypothesis differ between the two aggregation theories, they all seem counterfactual.

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This chapter was published in:

  • Daron Acemoglu & Kenneth Rogoff & Michael Woodford, 2007. "NBER Macroeconomics Annual 2006, Volume 21," NBER Books, National Bureau of Economic Research, Inc, number acem06-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 11179.

    Handle: RePEc:nbr:nberch:11179

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    1. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
    2. Paul Gomme & Richard Rogerson & Peter Rupert & Randall Wright, 2004. "The business cycle and the life cycle," Working Paper 0404, Federal Reserve Bank of Cleveland.
    3. Carneiro, Pedro & Heckman, James J., 2003. "Human Capital Policy," IZA Discussion Papers 821, Institute for the Study of Labor (IZA).
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    5. John Rust & Christopher Phelan, 1997. "How Social Security and Medicare Affect Retirement Behavior in a World of Incomplete Markets," Econometrica, Econometric Society, vol. 65(4), pages 781-832, July.
    6. Edward C. Prescott & Richard Rogerson & Johanna Wallenius, 2009. "Lifetime Aggregate Labor Supply with Endogenous Workweek Length," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 23-36, January.
    7. Shaw, Kathryn L, 1989. "Life-Cycle Labor Supply with Human Capital Accumulation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(2), pages 431-56, May.
    8. Yongsung Chang & Sun-Bin Kim, 2006. "From Individual To Aggregate Labor Supply: A Quantitative Analysis Based On A Heterogeneous Agent Macroeconomy ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(1), pages 1-27, 02.
    9. Chiappori, Pierre-Andre, 1992. "Collective Labor Supply and Welfare," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 437-67, June.
    10. Mulligan Casey B, 2001. "Aggregate Implications of Indivisible Labor," The B.E. Journal of Macroeconomics, De Gruyter, vol. 1(1), pages 1-35, April.
    11. Jones, Larry E., 2008. "A Note On The Joint Occurrence Of Insurance And Gambling," Macroeconomic Dynamics, Cambridge University Press, vol. 12(01), pages 97-111, February.
    12. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
    13. Burda, Michael C. & Mertens, Antje, 2001. "Estimating wage losses of displaced workers in Germany," Labour Economics, Elsevier, vol. 8(1), pages 15-41, January.
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    15. Susumu Imai & Michael P. Keane, 2004. "Intertemporal Labor Supply and Human Capital Accumulation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 601-641, 05.
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    Cited by:
    1. Richard Rogerson & Johanna Wallenius, 2007. "Micro and Macro Elasticities in a Life Cycle Model With Taxes," NBER Working Papers 13017, National Bureau of Economic Research, Inc.
    2. Stéphane Auray & Samuel Danthine, 2009. "Bargaining Frictions, Labor Income Taxation, and Economic Performance," Cahiers de recherche 09-20, Departement d'Economique de la Faculte d'administration à l'Universite de Sherbrooke.
    3. Laun, Tobias & Wallenius, Johanna, 2013. "Social Insurance and Retirement: A Cross-Country Perspective," Working Paper Series in Economics and Finance 744, Stockholm School of Economics.
    4. Per Krusell & Toshihiko Mukoyama & Richard Rogerson & Aysegul Sahin, 2009. "Aggregate Labor Market Outcomes: The Role of Choice and Chance," NBER Working Papers 15252, National Bureau of Economic Research, Inc.
    5. Mathias Trabandt & Harald Uhlig, 2012. "How do Laffer curves differ across countries?," International Finance Discussion Papers 1048, Board of Governors of the Federal Reserve System (U.S.).
    6. Krusell, Per & Mukoyama, Toshihiko & Rogerson, Richard & Sahin, Aysegül, 2008. "Aggregate implications of indivisible labor, incomplete markets, and labor market frictions," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 961-979, July.
    7. Claudio Michelacci & Josep Pijoan-Mas, 2008. "The Effects of Labor Market Conditions on Working Time: the US-EU Experience," Working Paper Series 28-08, The Rimini Centre for Economic Analysis, revised Jan 2008.
    8. Trabandt, Mathias & Uhlig, Harald, 2011. "The Laffer curve revisited," Journal of Monetary Economics, Elsevier, vol. 58(4), pages 305-327.

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