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Tax Progression and Human Capital in Imperfect Labour Markets

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  • Clemens Fuest
  • Bernd Huber

Abstract

Recent contributions to the theory of taxation in imperfect labour markets argue that tax progression raises welfare and employment in the presence of involuntary unemployment. The underlying theoretical analysis takes the endowment of workers with human capital as given. It is well known, however, that tax progression reduces incentives to form human capital. This paper analyses the effects of tax progression in a model with imperfect labour markets and endogenous human capital formation. We show that tax progression reduces wages but also human capital investment. The decline in human capital formation has a negative impact on employment which outweighs the employment-enhancing effect of the lower wage rate, such that tax progression unambiguously reduces employment and welfare.

Suggested Citation

  • Clemens Fuest & Bernd Huber, "undated". "Tax Progression and Human Capital in Imperfect Labour Markets," EPRU Working Paper Series 98-03, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    • Handle: RePEc:kud:epruwp:98-03
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    Cited by:

    1. Boeters, Stefan, 2011. "Optimal tax progressivity in unionised labour markets: What are the driving forces?," Economic Modelling, Elsevier, vol. 28(5), pages 2282-2295, September.
    2. van Ewijk, Casper & Tang, Paul J.G., 2007. "Unions, progressive taxes, and education subsidies," European Journal of Political Economy, Elsevier, vol. 23(4), pages 1119-1139, December.
    3. Hungerbuhler, Mathias, 2007. "Tax progression and training in a matching framework," Labour Economics, Elsevier, vol. 14(2), pages 185-200, April.
    4. Wöhlbier, Florian, 2002. "Subsidising Education with Unionised Labour Markets," Discussion Papers in Economics 7, University of Munich, Department of Economics.
    5. Schindler Dirk, 2011. "Tuition Fees and the Dual Income Tax: The Optimality of the Nordic Income Tax System Reconsidered," German Economic Review, De Gruyter, vol. 12(1), pages 59-84, February.
    6. Bohringer, Christoph & Boeters, Stefan & Feil, Michael, 2005. "Taxation and unemployment: an applied general equilibrium approach," Economic Modelling, Elsevier, vol. 22(1), pages 81-108, January.
    7. Florian Dorn & Clemens Fuest & Björn Kauder & Luisa Lorenz & Martin Mosler & Luisa Dörr, 2017. "The removal of the middle class bulge - models and costs," ifo Forschungsberichte, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, number 77.
    8. Boeters, Stefan & Böhringer, Christoph & Feil, Michael, 2002. "Taxation and unemployment: an applied general equilibrium approach for Germany," ZEW Discussion Papers 02-39, ZEW - Leibniz Centre for European Economic Research.

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