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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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    References listed on IDEAS

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    1. Eaton, Jonathan & Rosen, Harvey S, 1980. "Taxation, Human Capital, and Uncertainty," American Economic Review, American Economic Association, vol. 70(4), pages 705-715, September.
    2. Trostel, Philip A, 1993. "The Effect of Taxation on Human Capital," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 327-350, April.
    3. Cahuc, Pierre & Michel, Philippe, 1996. "Minimum wage unemployment and growth," European Economic Review, Elsevier, vol. 40(7), pages 1463-1482, August.
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    5. B Bell & Stephen Nickell, 1996. "Would Cutting Payroll Taxes on the Unskilled Have a Significant Effect on Unemployment?," CEP Discussion Papers dp0276, Centre for Economic Performance, LSE.
    6. Fuest, Clemens & Huber, Bernd, 2000. "Is tax progression really good for employment? A model with endogenous hours of work," Labour Economics, Elsevier, vol. 7(1), pages 79-93, January.
    7. Pissarides, Christopher A., 1998. "The impact of employment tax cuts on unemployment and wages; The role of unemployment benefits and tax structure," European Economic Review, Elsevier, vol. 42(1), pages 155-183, January.
    8. Sorensen, Peter Birch, 1999. "Optimal tax progressivity in imperfect labour markets," Labour Economics, Elsevier, vol. 6(3), pages 435-452, September.
    9. Claus Thustrup Hansen, 1999. "Lower Tax Progression, Longer Hours and Higher Wages," Scandinavian Journal of Economics, Wiley Blackwell, vol. 101(1), pages 49-65, March.
    10. Nielsen, Soren Bo & Sorensen, Peter Birch, 1997. "On the optimality of the Nordic system of dual income taxation," Journal of Public Economics, Elsevier, vol. 63(3), pages 311-329, February.
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    Cited by:

    1. 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.
    2. 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.
    3. 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.
    4. 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, October.
    5. 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.
    6. Hungerbuhler, Mathias, 2007. "Tax progression and training in a matching framework," Labour Economics, Elsevier, vol. 14(2), pages 185-200, April.
    7. Wöhlbier, Florian, 2002. "Subsidising Education with Unionised Labour Markets," Discussion Papers in Economics 7, University of Munich, Department of Economics.
    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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