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Wage formation by majority voting and the incentive effects of pensions and taxation

  • Jukka Lassila

    (The Research Institute of the Finnish Economy, Finland)

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    We study median voter wage-setting and its dependence on pensions and taxation in a centralized monopoly union framework using a dynamic computable general equilibrium model with overlapping generations structure. We show that the higher is the earnings-related PAYG pension benefit level, the lower is the wage the voter chooses, for two reasons. Firstly, if the voter claims high current wages his lifetime wage income falls, which will lead to lower pensions, and the advantages of lower pension contributions go to future working generations. Secondly, the median voter has to pay higher contributions both because the current wage bill falls and because current pensions may increase due to indexation. Both these generational effects lead the median voter to choose lower wages, which leads to higher employment. When we compare median voter wage setting with labour markets where wages adjust to equate supply and demand, the difference is bigger when the incentives to work are stronger in the market equilibrium, and gets smaller when the incentives are weaker. When e.g. the pension benefits and the corresponding payroll tax are increased, the voting equilibrium wage level approaches the market equilibrium wage. Similar results are obtained with respect to labour and consumption taxes.

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    Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

    Volume (Year): 13 (2000)
    Issue (Month): 2 (Autumn)
    Pages: 89-115

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    Handle: RePEc:fep:journl:v:13:y:2000:i:2:p:89-115
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    17. Valkonen, Tarmo, 1995. "Corporate and Capital Income Tax Reform in a Numerical Overlapping Generations Model: The Case of Finland," Discussion Papers 543, The Research Institute of the Finnish Economy.
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