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Do Taxes Explain European Employment? Indivisible Labour, Human Capital, Lotteries and Savings

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  • Sargent, Thomas
  • Ljungqvist, Lars

Abstract

Adding generous government supplied benefits to Prescott's (2002) model with employment lotteries and private consumption insurance causes employment to implode and prevents the model from matching outcomes observed in Europe. To understand the role of a 'not-so-well-known aggregation theory' that Prescott uses to rationalize the high labour supply elasticity that underlies his finding that higher taxes on labour have depressed Europe relative to the US, this paper compares aggregate outcomes for economies with two arrangements for coping with indivisible labour: (1) employment lotteries plus complete consumption insurance, and (2) individual consumption smoothing via borrowing and lending at a risk-free interest rate. The two arrangements support equivalent outcomes when human capital is not present; when it is present, allocations differ because households' reliance on personal savings in the incomplete markets model constrains the 'career choices' that are implicit in their human capital acquisition plans relative to those that can be supported by lotteries and consumption insurance in the complete markets model. Nevertheless, the responses of aggregate outcomes to changes in tax rates are quantitatively similar across the two market structures. Thus, under both aggregation theories, the high disutility that Prescott assigns to labour is an impediment to explaining European non-employment and benefits levels. Moreover, while the identities of the non-employed under Prescott's tax hypothesis differ between the two aggregation theories, they all seem counterfactual.

Suggested Citation

  • Sargent, Thomas & Ljungqvist, Lars, 2007. "Do Taxes Explain European Employment? Indivisible Labour, Human Capital, Lotteries and Savings," CEPR Discussion Papers 6196, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6196
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    Cited by:

    1. Setty, Ofer, 2011. "Unemployment Accounts," Foerder Institute for Economic Research Working Papers 275748, Tel-Aviv University > Foerder Institute for Economic Research.
    2. Mathias Trabandt & Harald Uhlig, 2012. "How Do Laffer Curves Differ across Countries?," NBER Chapters, in: Fiscal Policy after the Financial Crisis, pages 211-249, National Bureau of Economic Research, Inc.
    3. repec:fip:fedmqr:y:2012:i:october:n:v.35no.2 is not listed on IDEAS
    4. Langot, François & Pizzo, Alessandra, 2019. "Accounting for labor gaps," European Economic Review, Elsevier, vol. 118(C), pages 312-347.
    5. Luksic, Jan, 2020. "The extensive macro labor supply elasticity: Integrating taxes and expenditures," European Economic Review, Elsevier, vol. 121(C).
    6. Lars Ljungvist & Thomas Sargent, 2014. "Career Length: Effects of Curvature of Earnings Profiles, Earnings Shocks, Taxes, and Social Security," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(1), pages 1-20, January.
    7. Mathias Trabandt & Harald Uhlig, 2012. "How Do Laffer Curves Differ across Countries?," NBER Chapters, in: Fiscal Policy after the Financial Crisis, pages 211-249, National Bureau of Economic Research, Inc.
    8. Auray, Stéphane & Danthine, Samuel, 2010. "Bargaining frictions, labor income taxation, and economic performance," European Economic Review, Elsevier, vol. 54(6), pages 778-802, August.
    9. Krusell, Per & Mukoyama, Toshihiko & Rogerson, Richard & Sahin, Aysegül, 2008. "Aggregate implications of indivisible labor, incomplete markets, and labor market frictions," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 961-979, July.
    10. Shigeki Kunieda, 2009. "Working Hours and Taxation," Japanese Economy, Taylor & Francis Journals, vol. 36(2), pages 3-22.
    11. Rogerson, Richard & Wallenius, Johanna, 2009. "Micro and macro elasticities in a life cycle model with taxes," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2277-2292, November.
    12. Trabandt, Mathias & Uhlig, Harald, 2011. "The Laffer curve revisited," Journal of Monetary Economics, Elsevier, vol. 58(4), pages 305-327.
    13. Edward C. Prescott & Johanna Wallenius, 2012. "Aggregate labor supply," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 35(Oct).
    14. Brendan Epstein & Miles S. Kimball, 2014. "The Decline of Drudgery and the Paradox of Hard Work," International Finance Discussion Papers 1106, Board of Governors of the Federal Reserve System (U.S.).
    15. Sun-Bin Kim & Frank Schorfheide & Yongsung Chang, 2010. "Financial Frictions, Aggregation, and the Lucas Critique," 2010 Meeting Papers 31, Society for Economic Dynamics.
    16. Tobias Laun & Johanna Wallenius, 2016. "Social Insurance and Retirement: A Cross-Country Perspective," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 22, pages 72-92, October.
    17. Michelacci, Claudio & Pijoan-Mas, Josep, 2007. "The Effects of Labor Market Conditions on Working Time: the US-EU Experience," CEPR Discussion Papers 6314, C.E.P.R. Discussion Papers.
    18. Rajit Biswas & Vandana Thandassery Ramakrishnan, 2022. "Taxes and unemployment," International Journal of Economic Theory, The International Society for Economic Theory, vol. 18(2), pages 182-194, June.
    19. Erling Holmøy, 2014. "The equilibrium relationship between public and total employment. The importance of endogenous non-labour income," Discussion Papers 779, Statistics Norway, Research Department.
    20. Per Krusell & Toshihiko Mukoyama & Richard Rogerson & Ayşegül Şahin, 2010. "Aggregate labor market outcomes: The roles of choice and chance," Quantitative Economics, Econometric Society, vol. 1(1), pages 97-127, July.
    21. Yongsung Chang & Sun-Bin Kim & Frank Schorfheide, 2010. "Labor-Market Heterogeneity, Aggregation, and the Lucas Critique," RCER Working Papers 556, University of Rochester - Center for Economic Research (RCER).

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    More about this item

    Keywords

    Aggregation theories; Employment lotteries; Human capital; Indivisible labour; Labour supply elasticity; Labour taxation; Social and private insurance;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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