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Taxes, subsidies and equilibrium labor market outcomes

  • Dale T Mortensen
  • Christopher Pissarides

We explore the effects of taxes and subsidies on job creation, job destruction, employment, and wages in the Mortensen-Pissarides version of the search and matching equilibrium framework. Qualitative analytical results show that wage and employment subsidies increase employment, especially of low skill workers, and also increase wages. A job creation or hiring subsidy reduces unemployment duration but increases incidence with an ambiguous effect on overall employment. A firing tax has the reverse effects but the same indeterminacy. In the special case of a competitive search equilibrium, the one in which search externalities are internalized, there is a first best configuration: no tax on the wage, an employment subsidy that offsets the distortions on the job destruction margin induced by unemployment compensation and employment protection policy, and a hiring subsidy equal to the implicit tax on severance imposed by any form of employment protection, with the costs of these and other policies financed by a non-distortionary consumption tax. Computational experiments confirm this ideal also determines the direction in which marginal improvements can be made both in terms of efficiency and in terms of improving low skill worker employment and wage outcomes.

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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 2075.

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Length: 37 pages
Date of creation: Sep 2001
Date of revision:
Handle: RePEc:ehl:lserod:2075
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  1. Barbara Petrongolo & Christopher A. Pissarides, 2000. "Looking Into the Black Box: A Survey of the Matching Function," CEP Discussion Papers dp0470, Centre for Economic Performance, LSE.
  2. Rubinstein, Ariel & Wolinsky, Asher, 1985. "Equilibrium in a Market with Sequential Bargaining," Econometrica, Econometric Society, vol. 53(5), pages 1133-50, September.
  3. Edmund S. Phelps, 1968. "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 76, pages 678.
  4. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  5. Dale T. Mortensen, 1982. "The Matching Process as a Noncooperative Bargaining Game," NBER Chapters, in: The Economics of Information and Uncertainty, pages 233-258 National Bureau of Economic Research, Inc.
  6. Wolinsky, Asher, 1987. "Matching, search, and bargaining," Journal of Economic Theory, Elsevier, vol. 42(2), pages 311-333, August.
  7. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, June.
  8. Diamond, Peter A, 1981. "Mobility Costs, Frictional Unemployment, and Efficiency," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 798-812, August.
  9. MacLeod, W Bentley & Malcomson, James M, 1993. "Investments, Holdup, and the Form of Market Contracts," American Economic Review, American Economic Association, vol. 83(4), pages 811-37, September.
  10. Carl Davidson & Stephen A. Woodbury, 2000. "Wage-Rate Subsidies for Dislocated Workers," Book chapters authored by Upjohn Institute researchers, in: Laurie J. Bassi & Stephen A. Woodbury (ed.), Long-term Unemployment and Reemployment Policies, pages 141-184 W.E. Upjohn Institute for Employment Research.
  11. Dale T. Mortensen, 1994. "Reducing supply-side disincentives to job creation," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Jan, pages 189-237.
  12. repec:oup:restud:v:49:y:1982:i:2:p:217-27 is not listed on IDEAS
  13. Dale T. Mortensen, 1978. "Specific Capital and Labor Turnover," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 572-586, Autumn.
  14. Burda, Michael C, 1992. " A Note on Firing Costs and Severance Benefits in Equilibrium Unemployment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 94(3), pages 479-89.
  15. repec:oup:qjecon:v:105:y:1990:i:3:p:699-726 is not listed on IDEAS
  16. repec:oup:restud:v:57:y:1990:i:2:p:279-98 is not listed on IDEAS
  17. repec:oup:restud:v:61:y:1994:i:3:p:397-415 is not listed on IDEAS
  18. Wood Júnior, Thomaz, 1995. "Workers," RAE - Revista de Administração de Empresas, FGV-EAESP Escola de Administração de Empresas de São Paulo (Brazil), vol. 35(2), January.
  19. Pissarides, Christopher A, 1985. "Short-run Equilibrium Dynamics of Unemployment Vacancies, and Real Wages," American Economic Review, American Economic Association, vol. 75(4), pages 676-90, September.
  20. George J. Stigler, 1961. "The Economics of Information," Journal of Political Economy, University of Chicago Press, vol. 69, pages 213.
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