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Labor market frictions, capital, taxes and employment

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  • Kangoh Lee

    (San Diego State University)

Abstract

This paper studies the role of the tax on mobile capital in labor markets with matching frictions and the effects of such frictions on inefficiency of capital taxation. Firms acquire capital and create vacancies, and workers apply for firms. Due to matching frictions, vacancies may not be filled, and workers may not be employed. Firms’ investment in capital, wages and market tightness are determined in a way that a firm’s profit and a worker’s utility are jointly maximized. In addition, the return to capital net of the tax is equalized across jurisdictions, as capital moves between jurisdictions. An increase in the capital tax of a jurisdiction alters firms’ capital investment, wages and market tightness of the jurisdiction. In particular, it decreases employment and wages of the jurisdiction, providing an explanation for why policymakers of a jurisdiction provide incentives such as tax cuts for mobile capital. More capital increases the wages only when workers are employed and hence have higher incomes, decreasing the benefit of more capital for risk-averse workers and reducing the incentives of a jurisdiction to lower the tax and attract capital. The equilibrium capital tax thus may be too low or too high relative to the efficient level, and capital is taxed even with the head tax.

Suggested Citation

  • Kangoh Lee, 2021. "Labor market frictions, capital, taxes and employment," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 28(6), pages 1329-1359, December.
  • Handle: RePEc:kap:itaxpf:v:28:y:2021:i:6:d:10.1007_s10797-020-09649-8
    DOI: 10.1007/s10797-020-09649-8
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    1. Guerrazzi, Marco, 2022. "Optimal growth with labour market frictions," MPRA Paper 114422, University Library of Munich, Germany.

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    More about this item

    Keywords

    Matching frictions; Capital; Risk aversion; Employment; Taxes;
    All these keywords.

    JEL classification:

    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • H73 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Interjurisdictional Differentials and Their Effects
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • R12 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - Size and Spatial Distributions of Regional Economic Activity; Interregional Trade (economic geography)
    • R13 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General Equilibrium and Welfare Economic Analysis of Regional Economies

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