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On the Optimality of a Minimum Wage: New Insights from Optimal Tax Theory

Author Info

  • Hungerbühler, Mathias

    ()

    (University of Namur)

  • Lehmann, Etienne

    ()

    (CRED, Université Panthéon Assas Paris 2)

Abstract

We build a theoretical model to study whether a minimum wage can be welfare-improving if it is implemented in conjunction with an optimized nonlinear income tax. We consider this issue in a framework where search frictions on the labor market generate unemployment. Workers differ in productivity. The government does not observe workers’ productivity but only their wages. Hence, the redistributive policy solves an adverse selection problem. We show that a minimum wage is optimal if the bargaining power of the workers is relatively low. However, if the government controls the bargaining power, then it is preferable to set a sufficiently high bargaining power.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2957.

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Length: 32 pages
Date of creation: Jul 2007
Date of revision:
Publication status: published in: Journal of Public Economics, 2009, 93 (3-4), 464-481
Handle: RePEc:iza:izadps:dp2957
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Keywords: bunching; optimal taxation; minimum wage; search-matching unemployment; wage bargaining;

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Find related papers by JEL classification:
  • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
  • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
  • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
  • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
  • J68 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Public Policy

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  1. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
  2. Robin Boadway & Katherine Cuff, 1999. "A Minimum Wage Can Be Welfare-Improving and Employment-Enhancing," Cahiers de recherche CREFE / CREFE Working Papers 72, CREFE, Université du Québec à Montréal.
  3. Hungerbühler, Mathias & Lehmann, Etienne & Parmentier, Alexis & Van der Linden, Bruno, 2005. "Optimal Redistributive Taxation in a Search Equilibrium Model," IZA Discussion Papers 1460, Institute for the Study of Labor (IZA).
  4. DREZE, Jacques & GOLLIER, Christian, . "Risk sharing on the labour market and second-best wage rigidities," CORE Discussion Papers RP -1073, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Petrongolo, Barbara & Pissarides, Christopher, 2000. "Looking Into The Black Box: A Survey Of The Matching Function," CEPR Discussion Papers 2409, C.E.P.R. Discussion Papers.
  6. Boone, Jan & Bovenberg, Lans, 2002. "Optimal labour taxation and search," Journal of Public Economics, Elsevier, vol. 85(1), pages 53-97, July.
  7. Guesnerie, Roger & Roberts, Kevin, 1987. "Minimum wage legislation as a second best policy," European Economic Review, Elsevier, vol. 31(1-2), pages 490-498.
  8. Pierre Cahuc & Guy Laroque, 2009. "Optimal Taxation and Monopsonistic Labor Market: Does Monopsony justify the Minimum Wage?," Working Papers hal-00396252, HAL.
  9. Pierre Cahuc & André Zylberberg, 2004. "Labor Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 026203316x, June.
  10. Joseph E. Stiglitz, 1981. "Self-Selection and Pareto Efficient Taxation," NBER Working Papers 0632, National Bureau of Economic Research, Inc.
  11. Feve, Patrick & Langot, Francois, 1996. "Unemployment and the business cycle in a small open economy: G.M.M. estimation and testing with French data," Journal of Economic Dynamics and Control, Elsevier, vol. 20(9-10), pages 1609-1639.
  12. Marceau, Nicolas & Boadway, Robin, 1994. " Minimum Wage Legislation and Unemployment Insurance as Instruments for Redistribution," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(1), pages 67-81.
  13. Mortensen, Dale T & Pissarides, Christopher, 1999. "New Developments in Models of Search in the Labour Market," CEPR Discussion Papers 2053, C.E.P.R. Discussion Papers.
  14. Allen, Franklin, 1982. "Optimal linear income taxation with general equilibrium effects on wages," Journal of Public Economics, Elsevier, vol. 17(2), pages 135-143, March.
  15. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  16. Lollivier, Stefan & Rochet, Jean-Charles, 1983. "Bunching and second-order conditions: A note on optimal tax theory," Journal of Economic Theory, Elsevier, vol. 31(2), pages 392-400, December.
  17. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, June.
  18. David Lee & Emmanuel Saez, 2008. "Optimal Minimum Wage Policy in Competitive Labor Markets," NBER Working Papers 14320, National Bureau of Economic Research, Inc.
  19. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  20. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
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