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Optimal Taxation with On-the-Job Search

Author

Listed:
  • Jesper Bagger

    (Royal Holloway, University of London)

  • Espen Moen

    (Norwegian Business School)

  • Rune Vejlin

    (Aarhus University)

Abstract

We provide a theoretical and empirical study of the optimal taxation of labor income in the presence of search frictions and unobservable amenities using comprehensive Danish matched employer-employee data. Heterogeneous workers undertake costly search off- and on-the-job in order to locate more productive jobs that pay higher wages. More productive workers search harder, resulting in equilibrium sorting where low-type workers are overrepresented in low-wage jobs while high-type workers are overrepresented in high-wage jobs. Absent taxes, worker search effort is efficient, because the social and private gains from search coincide. The optimal tax system balance efficiency and equity concerns at the margin. Equity concerns make it desirable to levy low taxes on (or indeed, subsidize) low-wage jobs including unemployment, and levy high taxes on high-wage jobs. Efficiency concerns limit how much taxes an optimal tax system levy on high-paid jobs, as high taxes distort the workers' incentives to search. Using detailed micro data on wages, labor market transitions, and income tax filings we estimate the structural model and compare the the actual Danish tax regime with the optimal one. Preliminary results suggest the optimal tax schedule exhibits less progressivity than the actual tax system in place. The model allows us to quantify the welfare gains from adopting an optimal income tax schedule.

Suggested Citation

  • Jesper Bagger & Espen Moen & Rune Vejlin, 2018. "Optimal Taxation with On-the-Job Search," 2018 Meeting Papers 805, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:805
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    References listed on IDEAS

    as
    1. Guillaume Wilemme, 2017. "Optimal Taxation to Correct Job Mismatching," Working Papers halshs-01531309, HAL.
    2. Athanasios Geromichalos, 2015. "Unemployment Insurance and Optimal Taxation in a Search Model of the Labor Market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 365-380, April.
    3. 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.
    4. Hakki Yazici & Christopher Sleet, 2017. "Taxation, Redistribution and Frictional Labor Supply," 2017 Meeting Papers 298, Society for Economic Dynamics.
    5. Bent Jesper Christensen & Rasmus Lentz & Dale T. Mortensen & George R. Neumann & Axel Werwatz, 2005. "On-the-Job Search and the Wage Distribution," Journal of Labor Economics, University of Chicago Press, vol. 23(1), pages 31-58, January.
    6. Christian Giødesen Lund & Rune Vejlin, 2015. "Documenting and Improving the Hourly Wage Measure in the Danish IDA Database," Economics Working Papers 2015-06, Department of Economics and Business Economics, Aarhus University.
    7. Mikhail Golosov & Pricila Maziero & Guido Menzio, 2013. "Taxation and Redistribution of Residual Income Inequality," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1160-1204.
    8. Wei Jiang, 2014. "Tax Reforms in Search-and-Matching Models with Heterogeneous Agents," Studies in Economics 1414, School of Economics, University of Kent.
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