Optimal Taxation in Search Equilibrium

University dissertation from Uppsala : Nationalekonomiska institutionen

Abstract: This thesis consists of four self-contained essays.Essay 1 (with Bertil Holmlund and Ann-Sofie Kolm) develops a two-sector general equilibrium search model where ``goods'' are produced exclusively in the market and ”services” are produced both in the market and within the households. We use the model to examine how unemployment and welfare are affected by labor taxes in general and sectoral tax differentiation in particular. We find that a tax cut on services reduces unemployment whereas a tax cut on goods has no effect. A reform involving tax differentiation, with lower taxes on services, is welfare improving. Numerical calibrations of the model suggest that the welfare gains from tax differentiation are large if the government absorbs a substantial fraction of GDP.Essay 2 extends the basic Stiglitz (1982) model of optimal income taxation into general search equilibrium. The analysis of a labor market with unemployment introduces some new interesting mechanisms. When wages are fixed we find that a ''work-hour effect''\ gives the government incentives to lower the marginal tax rates for both high- and low-skilled workers, relative the outcome in a Walrasian economy. The optimal marginal tax on high-skilled workers is negative, whereas the marginal tax on low-skilled workers can take either sign. The results are changed when wages are determined by bargaining between firms and workers. Both marginal tax rates are of ambiguous signs. The tax systems' effects on the wage formation and the unemployment rates result in new intricate redistribution channels.Essay 3 explores the rationale for unemployment benefits as a complement to optimal non-linear income taxation. High-skilled workers and low-skilled workers face different exogenous risks of being unemployed. As long as the low-skilled workers face a higher unemployment risk, we find that there is a case for over-insuring the low-skilled, hence the unemployment benefits intended for the low-skilled should be higher than the pure insurance purpose would prescribe. This effect is likely to prevail in a model with\ a more realistic treatment of the labor market.Essay 4 explores the optimal mix of tax-transfer systems in a two-type model. The labor markets are imperfect due to search frictions. The tax instruments at the government's disposal are a non-linear tax function and unemployment benefits that may differ between the two types of workers. We find that even though workers are risk-neutral -- so there is no insurance purpose of unemployment benefits -- there are reasons to use unemployment benefits to the low-skilled as an important part of the optimal redistribution system.

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