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Minimum Wage Policy with Optimal Taxes and Unemployment

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  • Adam M. Lavecchia

    (Department of Economics, University of Ottawa, Ottawa, ON)

Abstract

This paper sheds new light on the desirability of the minimum wage in the presence of an optimal non-linear income tax. Using a search-and-matching framework, I derive a novel condition that links the desirability of the minimum wage to three sufficient statistics: (1) the macro or general equilibrium labor force participation response to the minimum wage by low-skilled individuals; (2) the macro employment response to the minimum wage for low-skilled individuals; and (3) the welfare weight on low-skilled workers. This condition shows that the minimum wage is welfare improving if it pushes the labor market tightness – the ratio of the aggregate number of vacancies to low-skilled job seekers – closer to its efficient level. Guided by the theory, I estimate the first two sufficient statistics using an event study design, as well as state and federal minimum wage variation between 1979-2014. I estimate a macro participation elasticity of -0.24 and a macro employment elasticity of -0.32. The former represents new evidence on a previously overlooked margin of the minimum wage. With these estimates in hand, I simulate the total welfare gains from introducing a minimum wage beginning from the optimal income tax allocation. The simulations show that the minimum wage is welfare improving only if the government has very strong redistributive tastes.

Suggested Citation

  • Adam M. Lavecchia, 2018. "Minimum Wage Policy with Optimal Taxes and Unemployment," Working Papers 1801E, University of Ottawa, Department of Economics.
    • Handle: RePEc:ott:wpaper:1801e
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    8. Epstein, Brendan & Nunn, Ryan & Orak, Musa & Patel, Elena, 2023. "Taxation, social welfare, and labor market frictions," European Economic Review, Elsevier, vol. 151(C).
    9. Boadway,Robin & Cuff,Katherine, 2022. "Tax Policy," Cambridge Books, Cambridge University Press, number 9781108949453, September.
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    More about this item

    Keywords

    Minimum wage; Sufficient statistics; Optimal policy; Labor force participation;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure
    • J38 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Public Policy
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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