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Effects of Progressive Taxes under Decentralized Bargaining and Heterogeneous Labor

  • Jon Strand


We consider changes in income tax progressivity in an economy where workers' productivities differ and workers and firms bargain individually over wages. With given employment a pure increase in tax progressivity reduces wages by reducing workers' relative bargaining power. When average taxes also increase, after-tax wages are unambiguously reduced, while the effects on gross wages and firm profitability are ambiguous. We next endogenize employment and firm entry under a uniform worker productivity distribution and the government's only policy instrument is a linear income tax. While a first-best solution then is ruled out, a second-best solution can be implemented using a family of linear tax functions, where a more progressive tax implies a higher tax revenue to the government. We show that the government can increase its tax revenue, and reduce after-tax income differences, without any additional disturbance to allocation. Copyright Kluwer Academic Publishers 2002

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Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 9 (2002)
Issue (Month): 2 (March)
Pages: 195-210

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Handle: RePEc:kap:itaxpf:v:9:y:2002:i:2:p:195-210
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