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Heterogeneous Labor Skills, The Median Voter and Labor Taxes

  • Facundo Piguillem

    (EIEF)

  • Anderson L. Schneider

    (University of Minnesota and FRB Minneapolis)

We explore the relationship between changes in labor income inequality and movements in labor taxes over the last decades in the US. In order to do so, we model this relation through a political economy channel by developing a median voter result over sequences of capital and labor taxes. We study an in nite horizon economy in which agents are heterogeneous with respect to both initial wealth and labor skills. The rst result is the following: if initial capital holdings are an ane function of skills, then the median agent is decisive in any pairwise majority rule election. The second result provides the characterization of the most preferred tax sequence by the median agent: marginal taxes on labor depend directly on the absolute value of the distance between the median and the mean value of the skill distribution. Finally, numerical simulations show that temporary increases in inequality could imply either higher or lower labor taxes, depending on the sign of the correlation between inequality and TFP. This nding provides a simple an intuitive answer to why scal policy is procyclical in some countries. When calibrated for the US economy, the model does a good job on tting both the increasing trend and the levels of labor taxes in the last decades, and on matching short run co-movements.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1002.

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Length: 49 pages
Date of creation: 2010
Date of revision: Nov 2009
Handle: RePEc:eie:wpaper:1002
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