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Optimal Income Taxation and Commitment on the Labor Market

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  • Paweł Doligalski

    (University of Bristol)

Abstract

The optimal income taxation literature typically assumes that labor is traded on the spot markets. I relax this assumption by equipping workers and firms with a commitment power and, as a consequence, allowing for more sophisticated labor contracts. The main finding is that when both workers and firms have any positive commitment power, the tax schedule cannot be too regressive, as otherwise wages would be inefficiently randomized to reduce the expected tax paid by workers. I also show that the insurance of workers depends only on the total commitment power on the labor market, but not on its division between workers and firms. I calibrate the model to the US income distribution. The threat of wage randomization reduces the optimal marginal tax rates at low income levels by up to 40 percentage points and in certain cases makes the optimal tax schedule fully linear.

Suggested Citation

  • Paweł Doligalski, 2019. "Optimal Income Taxation and Commitment on the Labor Market," 2019 Meeting Papers 422, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:422
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    Cited by:

    1. Paweł Doligalski & Abdoulaye Ndiaye & Nicolas Werquin, 2023. "Redistribution with Performance Pay," Journal of Political Economy Macroeconomics, University of Chicago Press, vol. 1(2), pages 371-402.
    2. Hazrati, Manochehr & Bafandeh Zendeh, Alireza & Aali, Samad, 2020. "Modeling of Real Estate Income Tax: System Dynamics Approach," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 15(4), pages 463-487, October.

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