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

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  • 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.

Suggested Citation

  • Hungerbühler, Mathias & Lehmann, Etienne, 2007. "On the Optimality of a Minimum Wage: New Insights from Optimal Tax Theory," IZA Discussion Papers 2957, Institute for the Study of Labor (IZA).
    • Handle: RePEc:iza:izadps:dp2957
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    References listed on IDEAS

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    1. Pierre Cahuc & Guy Laroque, 2014. "Optimal Taxation and Monopsonistic Labor Market: Does Monopsony Justify the Minimum Wage?," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 16(2), pages 259-273, April.
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    4. Mathias Hungerbühler & Etienne Lehmann & Alexis Parmentier & Bruno Van Der Linden, 2006. "Optimal Redistributive Taxation in a Search Equilibrium Model," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 743-767.
    5. 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.
    6. Boadway, Robin & Cuff, Katherine, 2001. "A minimum wage can be welfare-improving and employment-enhancing," European Economic Review, Elsevier, vol. 45(3), pages 553-576, March.
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    8. 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.
    9. 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.
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    12. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, vol. 17(2), pages 213-240, March.
    13. Lee, David & Saez, Emmanuel, 2012. "Optimal minimum wage policy in competitive labor markets," Journal of Public Economics, Elsevier, vol. 96(9-10), pages 739-749.
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    16. Mortensen, Dale T. & Pissarides, Christopher A., 1999. "New developments in models of search in the labor market," Handbook of Labor Economics,in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 39, pages 2567-2627 Elsevier.
    17. J. A. Mirrlees, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Oxford University Press, vol. 38(2), pages 175-208.
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    Citations

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    Cited by:

    1. Mathias Hungerbuhler & Etienne Lehmann & Alexis Parmentier & Bruno Van Der Linden, 2010. "A Simple Theory of Optimal Redistributive Taxation with Equilibrium Unemployment," Working Papers 2010-13, Center for Research in Economics and Statistics.
    2. Demougin, Dominique M. & Helm, Carsten, 2008. "Incentive contracts and efficient unemployment benefits," Darmstadt Discussion Papers in Economics 191, Darmstadt University of Technology, Department of Law and Economics.
    3. Finn Martensen, 2014. "Routinization and the Decline of the U.S. Minimum Wage," Working Paper Series of the Department of Economics, University of Konstanz 2014-16, Department of Economics, University of Konstanz.
    4. Eliav Danziger & Leif Danziger, 2018. "The Optimal Graduated Minimum Wage and Social Welfare," CESifo Working Paper Series 6943, CESifo Group Munich.
    5. Lee, David & Saez, Emmanuel, 2012. "Optimal minimum wage policy in competitive labor markets," Journal of Public Economics, Elsevier, vol. 96(9-10), pages 739-749.
    6. Eliav Danziger & Leif Danziger, 2015. "A Pareto-improving Minimum Wage," Economica, London School of Economics and Political Science, vol. 82(326), pages 236-252, April.
    7. Jacquet, Laurence & Lehmann, Etienne & Van der Linden, Bruno, 2011. "Optimal Redistributive Taxation with Both Labor Supply and Labor Demand Responses," IZA Discussion Papers 5642, Institute for the Study of Labor (IZA).
    8. Adam M. Lavecchia, 2018. "Minimum Wage Policy with Optimal Taxes and Unemployment," Working Papers 1801E, University of Ottawa, Department of Economics.
    9. Danziger, Eliav & Danziger, Leif, 2018. "The Optimal Graduated Minimum Wage and Social Welfare," IZA Discussion Papers 11386, Institute for the Study of Labor (IZA).
    10. Lehmann, Etienne & Parmentier, Alexis & Van Der Linden, Bruno, 2011. "Optimal income taxation with endogenous participation and search unemployment," Journal of Public Economics, Elsevier, vol. 95(11), pages 1523-1537.
    11. repec:pri:cepsud:178lee is not listed on IDEAS
    12. Pierre Cahuc & Guy Laroque, 2014. "Optimal Taxation and Monopsonistic Labor Market: Does Monopsony Justify the Minimum Wage?," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 16(2), pages 259-273, April.
    13. Laurence Jacquet & Etienne Lehmann & Bruno Linden, 2014. "Optimal income taxation with Kalai wage bargaining and endogenous participation," Social Choice and Welfare, Springer;The Society for Social Choice and Welfare, vol. 42(2), pages 381-402, February.
    14. Tomer Blumkin & Leif Danziger, 2014. "Deserving Poor and the Desirability of Minimum Wage Rules," CESifo Working Paper Series 4721, CESifo Group Munich.
    15. Yılmaz Ensar, 2016. "Market Imperfections and Income Distribution," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 16(2), pages 1147-1167, April.
    16. Nicholas Lawson, 2014. "Taxing the Job Creators: Efficient Progressive Taxation with Wage Bargaining," AMSE Working Papers 1442, Aix-Marseille School of Economics, Marseille, France, revised Aug 2014.
    17. Aart Gerritsen & Bas Jacobs, 2016. "Is a Minimum Wage an Appropriate Instrument for Redistribution?," Tinbergen Institute Discussion Papers 16-100/VI, Tinbergen Institute.
    18. Danziger, Eliav & Danziger, Leif, 2018. "The Optimal Graduated Minimum Wage and Social Welfare," GLO Discussion Paper Series 188, Global Labor Organization (GLO).
    19. David S. Lee & Emmanuel Saez, 2008. "Optimal Minimum Wage Policy in Competitive Labor Markets," Working Papers 1105, Princeton University, Department of Economics, Industrial Relations Section..
    20. Robin Boadway, 2012. "Recent Advances in Optimal Income Taxation," Hacienda Pública Española, IEF, vol. 200(1), pages 15-39, March.
    21. George Economides & Thomas Moutos, 2014. "Minimum Wages as a Redistributive Device in the Long Run," CESifo Working Paper Series 5052, CESifo Group Munich.
    22. Blumkin, Tomer & Danziger, Leif, 2014. "Deserving Poor and the Desirability of a Minimum Wage," IZA Discussion Papers 8418, Institute for the Study of Labor (IZA).
    23. Aart Gerritsen & Bas Jacobs, 2014. "Is a Minimum Wage an Appropriate Instrument for Redistribution?," CESifo Working Paper Series 4588, CESifo Group Munich.
    24. Manon Domingues dos santos & Etienne Lehmann, 2012. "Wage Rigidity or Fiscal Redistribution: The credibility Issue," Economics Bulletin, AccessEcon, vol. 32(4), pages 2801-2807.
    25. Nicholas Lawson, 2014. "Taxing the Job Creators: Effcient Progressive Taxation with Wage Bargaining," Working Papers halshs-01059604, HAL.

    More about this item

    Keywords

    bunching; optimal taxation; minimum wage; search-matching unemployment; wage bargaining;

    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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