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Taxes, Subsidies and Equilibrium Labour Market Outcomes

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Author Info
Mortensen, Dale T
Pissarides, Christopher

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Abstract

We explore the effects of taxes and subsidies on job creation, job destruction, employment and wages in the Mortensen-Pissarides version of the search and matching equilibrium framework. Qualitative analytical results show that wage and employment subsidies increase employment, especially of low skill workers, and also increase wages. A job creation or hiring subsidy reduces unemployment duration but increases incidence with an ambiguous effect on overall employment. A firing tax has the reverse effects but the same indeterminacy. In the special case of a competitive search equilibrium, in which search externalities are internalized, there is a first best configuration. The results are: no tax on the wage, an employment subsidy that offsets the distortions on the job destruction margin induced by unemployment compensation and employment protection policy, as well as a hiring subsidy equal to the implicit tax on severance imposed by any form of employment protection. The costs of these and other policies are financed by a non-distortionary consumption tax. Computational experiments confirm this ideal also determines the direction in which marginal improvements can be made both in terms of efficiency and in terms of improving low skill worker employment and wage outcomes.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2989.

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Date of creation: Oct 2001
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Handle: RePEc:cpr:ceprdp:2989

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Related research
Keywords: employment subsidies; employment taxes; firing tax; hiring subsidy; search and matching; unemployment; wage inequality; wage taxes;

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Find related papers by JEL classification:
H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search
J68 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Public Policy

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  1. Wolinsky, Asher, 1987. "Matching, search, and bargaining," Journal of Economic Theory, Elsevier, vol. 42(2), pages 311-333, August. [Downloadable!] (restricted)
  2. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October. [Downloadable!] (restricted)
    Other versions:
  3. Dale T. Mortensen, 1982. "The Matching Process as a Noncooperative Bargaining Game," NBER Chapters, in: The Economics of Information and Uncertainty, pages 233-258 National Bureau of Economic Research, Inc. [Downloadable!]
  4. Edmund S. Phelps, 1968. "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 76, pages 678. [Downloadable!] (restricted)
  5. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Blackwell Publishing, vol. 61(3), pages 397-415, July. [Downloadable!] (restricted)
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  6. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Blackwell Publishing, vol. 57(2), pages 279-98, April. [Downloadable!] (restricted)
  7. Ken Binmore & Ariel Rubinstein & Asher Wolinsky, 1986. "The Nash Bargaining Solution in Economic Modelling," RAND Journal of Economics, The RAND Corporation, vol. 17(2), pages 176-188, Summer. [Downloadable!] (restricted)
  8. Burda, Michael C, 1992. " A Note on Firing Costs and Severance Benefits in Equilibrium Unemployment," Scandinavian Journal of Economics, Blackwell Publishing, vol. 94(3), pages 479-89.
  9. Dale T. Mortensen, 1979. "The Matching Process as a Non-Cooperative/Bargaining Game," Discussion Papers 384, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
  10. Diamond, Peter A, 1982. "Wage Determination and Efficiency in Search Equilibrium," Review of Economic Studies, Blackwell Publishing, vol. 49(2), pages 217-27, April. [Downloadable!] (restricted)
  11. Carl Davidson & Stephen A. Woodbury, 1995. "Wage Subsidies for Dislocated Workers," Staff Working Papers 95-31, W.E. Upjohn Institute for Employment Research. [Downloadable!] (restricted)
  12. Pissarides, Christopher A, 1985. "Short-run Equilibrium Dynamics of Unemployment Vacancies, and Real Wages," American Economic Review, American Economic Association, vol. 75(4), pages 676-90, September. [Downloadable!] (restricted)
  13. MacLeod, W Bentley & Malcomson, James M, 1993. "Investments, Holdup, and the Form of Market Contracts," American Economic Review, American Economic Association, vol. 83(4), pages 811-37, September. [Downloadable!] (restricted)
  14. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932.
  15. Diamond, Peter A, 1981. "Mobility Costs, Frictional Unemployment, and Efficiency," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 798-812, August. [Downloadable!] (restricted)
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  16. Dale T. Mortensen, 1978. "Specific Capital and Labor Turnover," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 572-586, Autumn. [Downloadable!] (restricted)
  17. Dale T. Mortensen, 1994. "Reducing supply-side disincentives to job creation," Proceedings, Federal Reserve Bank of Kansas City, issue Jan, pages 189-237.
  18. Lazear, Edward P, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, MIT Press, vol. 105(3), pages 699-726, August. [Downloadable!] (restricted)
  19. Rubinstein, Ariel & Wolinsky, Asher, 1985. "Equilibrium in a Market with Sequential Bargaining," Econometrica, Econometric Society, vol. 53(5), pages 1133-50, September. [Downloadable!] (restricted)
  20. Barbara Petrongolo & Christopher A. Pissarides, 2001. "Looking into the Black Box: A Survey of the Matching Function," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 390-431, June. [Downloadable!] (restricted)
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  21. George J. Stigler, 1961. "The Economics of Information," Journal of Political Economy, University of Chicago Press, vol. 69, pages 213. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Nikolai Stähler, 2005. "Employment protection : its effects on different skill groups and on the incentive to become skilled," Working Papers of the Research Group Heterogenous Labor 05-07, Research Group Heterogeneous Labor, University of Konstanz/ZEW Mannheim. [Downloadable!]
    Other versions:
  2. Postel-Vinay, Fabien & Turon, Hélène, 2006. "On-The-Job Search, Productivity Shocks and the Individual Earnings Process," CEPR Discussion Papers 5593, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. J.Ignacio García Pérez & Yolanda Rebollo Sanz, 2007. "The use of permanent contracts across Spanish regions: Do regional wage subsidies work?," Economic Working Papers at Centro de Estudios Andaluces E2007/07, Centro de Estudios Andaluces. [Downloadable!]
    Other versions:
  4. Florian Baumann & Nikolai Stähler, 2005. "Financing Unemployment Benefits: Dismissal versus Employment Taxes," Working Papers of the Research Group Heterogenous Labor 05-03, Research Group Heterogeneous Labor, University of Konstanz/ZEW Mannheim. [Downloadable!]
    Other versions:
  5. Laszlo Goerke & Markus Pannenberg, 2005. "Berufliche Weiterbildung "on-the-job" und Auflösung von Beschäftigungsverhältnissen," Working Papers of the Research Group Heterogenous Labor 04-22, Research Group Heterogeneous Labor, University of Konstanz/ZEW Mannheim. [Downloadable!]
  6. Gabriele Cardullo & Bruno Van der Linden, 2006. "Employment Subsidies and Substitutable Skills: An Equilibrium Matching Approach," IZA Discussion Papers 2073, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  7. Anna, BATYRA & Henri R., SNEESSENS, 2007. "Selective Reductions in Labour Taxation : Labour Market Adjustments and Macroeconomic Performance," Discussion Papers (ECON - Département des Sciences Economiques) 2007001, Université catholique de Louvain, Département des Sciences Economiques. [Downloadable!]
    Other versions:
  8. Heijdra, B.J. & Ligthart, J.E., 2004. "Labor tax reform and equilibrium unemployment : a search and matching approach," Discussion Paper 89, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
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