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How Tax Progression Affects Effort and Employment

Author

Listed:
  • Koskela, Erkki

    (University of Helsinki)

  • Schöb, Ronnie

    (Free University of Berlin)

Abstract

Within an efficiency wage framework, we study the effects of two revenue-neutral tax reforms that change the progressivity of the labour tax system. A revenue-neutral increase in both the wage tax and tax exemption and a revenue-neutral change in the composition of labour taxation towards the tax with the smaller tax base will lead to the same results: they moderate wages, workers’ effort, effective labour input and aggregate output. Whether employment rises or falls, however, depends in both reforms on the magnitude of the pre-reform total tax wedge. The larger this tax wedge is, the more negative is the impact of reforms on workers’ effort. A larger total tax wedge increases the negative effect of tax progression on labour productivity and thus thwarts the positive employment effect of wage moderation.

Suggested Citation

  • Koskela, Erkki & Schöb, Ronnie, 2007. "How Tax Progression Affects Effort and Employment," IZA Discussion Papers 2861, IZA Network @ LISER.
    • Handle: RePEc:iza:izadps:dp2861
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    References listed on IDEAS

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    Cited by:

    1. Primož Dolenc & Suzana Laporšek, 2012. "Taxing wages and sustainable labour market performance: empirical evidence from OECD and EU countries," International Journal of Sustainable Economy, Inderscience Enterprises Ltd, vol. 4(3), pages 234-253.

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    Keywords

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    JEL classification:

    • H22 - Public Economics - - Taxation, Subsidies, and Revenue - - - Incidence
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • J48 - Labor and Demographic Economics - - Particular Labor Markets - - - Particular Labor Markets; Public Policy

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