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Nonlinear Employment Effects of Tax Policy

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  • DOMENICO FERRARO
  • GIUSEPPE FIORI

Abstract

We study the nonlinear propagation mechanism of tax policy in a heterogeneous‐agent equilibrium business cycle model with search frictions in the labor market and an extensive margin of employment adjustment. The model exhibits endogenous job destruction and endogenous hiring standards in the form of occasionally‐binding zero‐surplus constraints. After parameterizing the model using U.S. data, we find that the dynamic response of employment to a temporary change in the labor income tax is highly nonlinear, displaying sizable asymmetries and state dependence. Notably, the response to a tax rate cut is at least twice as large in a recession as in an expansion.

Suggested Citation

  • Domenico Ferraro & Giuseppe Fiori, 2023. "Nonlinear Employment Effects of Tax Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(5), pages 1001-1042, August.
    • Handle: RePEc:wly:jmoncb:v:55:y:2023:i:5:p:1001-1042
    DOI: 10.1111/jmcb.12984
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    More about this item

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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