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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, January.
    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. Yongsung Chang & Sun-Bin Kim, 2003. "From individual to aggregate labor supply : a quantitative analysis based on a heterogeneous agent macroeconomy," Working Paper, Federal Reserve Bank of Richmond 03-05, Federal Reserve Bank of Richmond.
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    4. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
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    7. 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.
    8. Richard Rogerson, 2010. "Indivisible Labor, Lotteries and Equilibrium," Levine's Working Paper Archive 250, David K. Levine.
    9. Paul Gomme & Richard Rogerson & Peter Rupert & Randall Wright, 2005. "The Business Cycle and the Life Cycle," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 415-592 National Bureau of Economic Research, Inc.
    10. John Rust & Christopher Phelan, 1997. "How Social Security and Medicare Affect Retirement Behavior in a World of Incomplete Markets," Econometrica, Econometric Society, Econometric Society, vol. 65(4), pages 781-832, July.
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    12. Carneiro, Pedro & Heckman, James J., 2003. "Human Capital Policy," IZA Discussion Papers 821, Institute for the Study of Labor (IZA).
    13. Casey B. Mulligan, 2001. "Aggregate Implications of Indivisible Labor," NBER Working Papers 8159, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Mathias Trabandt & Harald Uhlig, 2012. "How Do Laffer Curves Differ Across Countries?," Working Papers, Becker Friedman Institute for Research In Economics 2012-001, Becker Friedman Institute for Research In Economics.
    2. Claudio Michelacci & Josep Pijoan-Mas, 2007. "The Effects Of Labor Market Conditions On Working Time: The Us-Eu Experience," Working Papers, CEMFI wp2007_0705, CEMFI.
    3. Erling Holmøy, 2014. "The equilibrium relationship between public and total employment. The importance of endogenous non-labour income," Discussion Papers, Research Department of Statistics Norway 779, Research Department of Statistics Norway.
    4. Laun, Tobias & Wallenius, Johanna, 2013. "Social Insurance and Retirement: A Cross-Country Perspective," Working Paper Series, Center for Fiscal Studies 2013:6, Uppsala University, Department of Economics.
    5. 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.
    6. Auray, Stéphane & Danthine, Samuel, 2010. "Bargaining frictions, labor income taxation, and economic performance," European Economic Review, Elsevier, vol. 54(6), pages 778-802, August.
    7. 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.
    8. 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, Elsevier, vol. 55(5), pages 961-979, July.
    9. Mathias Trabandt & Harald Uhlig, 2006. "How Far Are We From The Slippery Slope? The Laffer Curve Revisited," SFB 649 Discussion Papers SFB649DP2006-023, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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