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On the Optimality of a Minimum Wage: New Insights from Optimal Tax Theory

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  • Hungerbühler, Mathias

    ()
    (University of Namur)

  • Lehmann, Etienne

    ()
    (CRED, Université Panthéon Assas Paris 2)

Abstract

We build a theoretical model to study whether a minimum wage can be welfare-improving if it is implemented in conjunction with an optimized nonlinear income tax. We consider this issue in a framework where search frictions on the labor market generate unemployment. Workers differ in productivity. The government does not observe workers’ productivity but only their wages. Hence, the redistributive policy solves an adverse selection problem. We show that a minimum wage is optimal if the bargaining power of the workers is relatively low. However, if the government controls the bargaining power, then it is preferable to set a sufficiently high bargaining power.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2957.

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Length: 32 pages
Date of creation: Jul 2007
Date of revision:
Publication status: published in: Journal of Public Economics, 2009, 93 (3-4), 464-481
Handle: RePEc:iza:izadps:dp2957

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Keywords: bunching; optimal taxation; minimum wage; search-matching unemployment; wage bargaining;

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References

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  1. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, Elsevier, vol. 17(2), pages 213-240, March.
  2. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  3. Lollivier, Stefan & Rochet, Jean-Charles, 1983. "Bunching and second-order conditions: A note on optimal tax theory," Journal of Economic Theory, Elsevier, Elsevier, vol. 31(2), pages 392-400, December.
  4. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  5. Barbara Petrongolo & Christopher Pissarides, 2000. "Looking into the black box: a survey of the matching function," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 2122, London School of Economics and Political Science, LSE Library.
  6. Boone, J. & Bovenberg, A.L., 2000. "Optimal Labour Taxation and Search," Discussion Paper, Tilburg University, Center for Economic Research 2000-17, Tilburg University, Center for Economic Research.
  7. Robin Boadway & Katherine Cuff, 1999. "A Minimum Wage Can Be Welfare-Improving and Employment-Enhancing," Cahiers de recherche CREFE / CREFE Working Papers, CREFE, Université du Québec à Montréal 72, CREFE, Université du Québec à Montréal.
  8. Mathias Hungerb�hler & Etienne Lehmann & Alexis Parmentier & Bruno Van Der Linden, 2006. "Optimal Redistributive Taxation in a Search Equilibrium Model," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 743-767.
  9. Allen, Franklin, 1982. "Optimal linear income taxation with general equilibrium effects on wages," Journal of Public Economics, Elsevier, Elsevier, vol. 17(2), pages 135-143, March.
  10. Dreze, Jacques H. & Gollier, Christian, 1993. "Risk sharing on the labour market and second-best wage rigidities," European Economic Review, Elsevier, Elsevier, vol. 37(8), pages 1457-1482, December.
  11. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262161877, December.
  12. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, Elsevier, vol. 25(3), pages 329-369, December.
  13. Feve, Patrick & Langot, Francois, 1996. "Unemployment and the business cycle in a small open economy: G.M.M. estimation and testing with French data," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 20(9-10), pages 1609-1639.
  14. Marceau, Nicolas & Boadway, Robin, 1994. " Minimum Wage Legislation and Unemployment Insurance as Instruments for Redistribution," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 96(1), pages 67-81.
  15. Cahuc, Pierre & Laroque, Guy, 2007. "Optimal Taxation and Monopsonistic Labour Market: Does Monopsony Justify the Minimum Wage?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6416, C.E.P.R. Discussion Papers.
  16. Guesnerie, Roger & Roberts, Kevin, 1987. "Minimum wage legislation as a second best policy," European Economic Review, Elsevier, Elsevier, vol. 31(1-2), pages 490-498.
  17. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 25-49, March.
  18. Pierre Cahuc & André Zylberberg, 2004. "Labor Economics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 026203316x, December.
  19. Mortensen, Dale T & Pissarides, Christopher, 1999. "New Developments in Models of Search in the Labour Market," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2053, C.E.P.R. Discussion Papers.
  20. David Lee & Emmanuel Saez, 2008. "Optimal Minimum Wage Policy in Competitive Labor Markets," NBER Working Papers 14320, National Bureau of Economic Research, Inc.
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