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How Tax Progression Affects Effort and Employment

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Author Info
Erkki Koskela () (University of Helsinki and IZA)
Ronnie Schöb () (Free University of Berlin)

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Abstract

Within an efficiency wage framework, we study the effects of two revenue-neutral tax reforms that change the progressivity of the labour tax system. A revenue-neutral increase in both the wage tax and tax exemption and a revenue-neutral change in the composition of labour taxation towards the tax with the smaller tax base will lead to the same results: they moderate wages, workers’ effort, effective labour input and aggregate output. Whether employment rises or falls, however, depends in both reforms on the magnitude of the prereform total tax wedge. The larger this tax wedge is, the more negative is the impact of reforms on workers’ effort. A larger total tax wedge increases the negative effect of tax progression on labour productivity and thus thwarts the positive employment effect of wage moderation.

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Publisher Info
Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2861.

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Length: 27 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:iza:izadps:dp2861

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Related research
Keywords: efficiency wages; tax progression; structure of labour taxation;

Find related papers by JEL classification:
H22 - Public Economics - - Taxation, Subsidies, and Revenue - - - Incidence
J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
J48 - Labor and Demographic Economics - - Particular Labor Markets - - - Particular Labor Markets; Public Policy

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References listed on IDEAS
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. Erkki Koskela & Ronnie Schöb, 2002. "Why Governments Should Tax Mobile Capital in the Presence of Unemployment," The B.E. Journal of Economic Analysis & Policy, Berkeley Electronic Press, vol. 0(1). [Downloadable!]
    Other versions:
  2. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June. [Downloadable!] (restricted)
  3. Koskela, Erkki & Vilmunen, Jouko, 1996. "Tax progression is good for employment in popular models of trade union behaviour," Labour Economics, Elsevier, vol. 3(1), pages 65-80, August. [Downloadable!] (restricted)
  4. Pierre Picard & Eric Toulemonde, 2000. "Taxation and Labor Markets," Econometric Society World Congress 2000 Contributed Papers 0707, Econometric Society. [Downloadable!]
  5. Pissarides, Christopher A., 1998. "The impact of employment tax cuts on unemployment and wages; The role of unemployment benefits and tax structure," European Economic Review, Elsevier, vol. 42(1), pages 155-183, January. [Downloadable!] (restricted)
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  6. Goerke, Laszlo, 1999. "Efficiency Wages and Taxes," Australian Economic Papers, Blackwell Publishing, vol. 38(2), pages 131-42, June. [Downloadable!] (restricted)
  7. Sorensen, Peter Birch, 1999. "Optimal tax progressivity in imperfect labour markets," Labour Economics, Elsevier, vol. 6(3), pages 435-452, September. [Downloadable!] (restricted)
  8. Solow, Robert M., 1979. "Another possible source of wage stickiness," Journal of Macroeconomics, Elsevier, vol. 1(1), pages 79-82. [Downloadable!] (restricted)
  9. Koskela, Erkki & Schob, Ronnie, 1999. "Does the composition of wage and payroll taxes matter under Nash bargaining?," Economics Letters, Elsevier, vol. 64(3), pages 343-349, September. [Downloadable!] (restricted)
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  10. Heijdra, Ben J. & Ligthart, Jenny E., 2004. "Labor tax reform and equilibrium unemployment: a search and matching approach," CCSO Working Papers 200409, University of Groningen, CCSO Centre for Economic Research. [Downloadable!]
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  11. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December. [Downloadable!] (restricted)
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