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Budget-neutral labour tax wedge reductions: A simulation-based analysis for selected euro area countries

Listed author(s):
  • Attinasi, Maria-Grazia
  • Prammer, Doris
  • Stähler, Nikolai
  • Tasso, Martino
  • Van Parys, Stefan

Budget-neutral tax wedge reductions rank high in the policy agenda of several EMU member states. Using a New Keynesian DSGE model of a monetary union with a complex labour market structure and a comprehensive public sector, we evaluate the macroeconomic and welfare effects of reducing the firms' and workers' labour tax rates under alternative financing instruments. Overall, a tax wedge reduction is beneficial in terms of both welfare and output, as long as the financing measure does not harm private-sector productivity and/or the incentive for private capital investments over-proportionately. While financing the labour tax wedge reduction by an increase in consumption taxation yields most favourable output effects, financing it by a reduction in government spending is more beneficial in terms of welfare as the latter does not imply a policy-induced increase in private consumption costs. We also show that, when we assume that firms can adjust the ex- and intensive labour margin in response to policy changes, a reduction in the workers' and not the firms' burden is most beneficial.

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File URL: https://www.econstor.eu/bitstream/10419/144766/1/865276420.pdf
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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Papers with number 26/2016.

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Date of creation: 2016
Handle: RePEc:zbw:bubdps:262016
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