Taxation, Redistribution and Frictional Labor Supply

We analyze the implications of ex ante dispersion in worker talents and a frictional labor market for the design of tax and benefit systems. Our model features on and off the job search, job ladders and equilibrium income and profit dispersion within talent markets. In a baseline setting with no talent dispersion, the optimal system consists of an unemployment benefit financed out of a simple lump sum tax on workers. The benefit is high enough to suppress worker income and firm profit dispersion, deter worker poaching and collapse job ladders. With talent dispersion, high benefit levels drive less talented workers out of the market and are prohibitively costly. Active talent markets are frictional. Taxes impact the dispersion of worker incomes and firm profits within these markets. These effects shape and modify conventional optimal tax formulas.