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Beyond the Labour Income Tax Wedge: The Unemployment-Reducing Effect of Tax Progressivity

  • Etienne LEHMANN

    ()

    (CRED (TEPP) University Panth eon-Assas Paris 2 and CREST, UCL-IRES, IDEP, IZA and CESifo)

  • Claudio LUCIFORA

    ()

    (Università Cattolica del Sacro Cuore, Milano and IZA)

  • Simone MORICONI

    ()

    (Università Cattolica del Sacro Cuore, Milano and Univerity of Luxembourg, CREA)

  • Bruno VAN DER LINDEN

    ()

    (FNRS and UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

This paper argues that, for a given overall level of labour income taxation, a more progressive tax schedule reduces the unemployment rate and increases the employment rate. From a theoretical point of view, higher progressivity induces a wage-moderation effect and increases overall employment since employment of low-paid workers is more responsive. We test these theoretical predictions on a panel of 21 OECD countries over 1998-2008. Controlling for the burden of taxation at the average wage, we show that a more progressive taxation reduces the unemployment rate and increases the employment rate. These findings are confirmed when we account for the potential endogeneity of both average taxation and progressivity. Overall our results suggest that policy-makers should not only focus on the detrimental effects of tax progressivity on in-work effort.

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Paper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2013018.

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Date of creation: 15 Jul 2013
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Handle: RePEc:ctl:louvir:2013018
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