This paper analyzes optimal taxation in an efficiency-wage economy with involuntary unemployment, thereby extending Chamley’s (1986) optimal-tax analysis of the standard full-employment case. For this purpose, we introduce optimal savings into the shirking-unemployment model of Shapiro and Stiglitz (1984), and go beyond their exclusive focus on steady-state equilibrium. Our most surprising result is that despite the presence of jobless workers the government should impose a positive tax (rather than subsidy) on wage income in the long run, if the labor market is sufficiently distorted.
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Paper provided by Carleton University, Department of Economics in its series Carleton Economic Papers with number
07-07.
Length: 19 pages Date of creation: 01 Jul 2007 Date of revision: Publication status: Published: Carleton Economic Paper Handle: RePEc:car:carecp:07-07
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