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Income Taxation and the Equilibrium Allocation of Labor

Author

Listed:
  • Jesper Bagger

    (Royal Holloway and the Dale T. Mortensen Centre)

  • Mads Hejlesen

    (Department of Economics and Business Economics, Aarhus University, Denmark)

  • Kazuhiko Sumiya

    (Royal Holloway)

  • Rune Vejlin

    (Department of Economics and Business Economics, Aarhus University, Denmark)

Abstract

We study the impact of labor income taxation on workers' job search behavior and the implications it has for the equilibrium allocation of heterogenous workers across heterogenous firms. The analysis is conducted within a complete markets equilibrium on-the-job search model with two-sided heterogeneity, endogenous job search effort and hiring intensity, equilibrium wage formation, and firm entry and exit. In a nutshell, by appropriating part of the gain from finding a better paid job, income taxation reduces the return to job search effort, and distorts workers' job search effort, which, in turn, distorts the equilibrium allocation of labor. The model is estimated on Danish matched employer-employee data, and is used to evaluate a series of tax reforms in Denmark in the 1990s and 2000s, to provide new insights into the elasticity of taxable labor income, and to identify a Pareto optimal income tax reform.

Suggested Citation

  • Jesper Bagger & Mads Hejlesen & Kazuhiko Sumiya & Rune Vejlin, 2018. "Income Taxation and the Equilibrium Allocation of Labor," Economics Working Papers 2018-06, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:aarhec:2018-06
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    References listed on IDEAS

    as
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    Cited by:

    1. Jean‐Baptiste Michau, 2021. "On the Provision of Insurance against Search‐Induced Wage Fluctuations," Scandinavian Journal of Economics, Wiley Blackwell, vol. 123(1), pages 382-414, January.
    2. Breda, Thomas & Haywood, Luke & Wang, Haomin, 2022. "Equilibrium Effects of Payroll Tax Reductions and Optimal Policy Design," IZA Discussion Papers 15810, Institute of Labor Economics (IZA).
    3. Kazuhiko Sumiya & Jesper Bagger, 2022. "Income Taxes, Gross Hourly Wages, and the Anatomy of Behavioral Responses: Evidence from a Danish Tax Reform," Economics Working Papers 2022-03, Department of Economics and Business Economics, Aarhus University.

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    More about this item

    Keywords

    Labor reallocation; Income taxation; Tax reforms; Worker heterogeneity; Firm heterogeneity; Matched employer-employee data;
    All these keywords.

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs

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