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Optimal Income Taxation with Endogenous Participation and Search Unemployment

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Abstract

This paper characterizes the optimal redistributive taxation when individuals are heterogeneous in two exogenous dimensions: their skills and their values of non-market activities. Search-matching frictions on the labor markets create unemployment. Wages, labor demand and participation are endogenous. The government only observes wage levels. Under a Maximin objective, if the elasticity of participation decreases along the distribution of skills, at the optimum, the average tax rate is increasing, marginal tax rates are positive everywhere, while wages, unemployment rates and participation rates are distorted downwards compared to their laissez-faire values. A simulation exercise confirms some of these properties under a general utilitarian objective. Taking account of the wage-cum-labor demand margin deeply changes the equity-efficiency trade off.

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  • Etienne Lehmann & Alexis Parmentier & Bruno van der Linden, 2008. "Optimal Income Taxation with Endogenous Participation and Search Unemployment," IDEP Working Papers 0805, Institut d'economie publique (IDEP), Marseille, France, revised 15 Sep 2008.
  • Handle: RePEc:iep:wpidep:0805
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    More about this item

    Keywords

    Non-linear taxation; redistribution; adverse selection; random participation; unemployment; labor market frictions.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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