Taxation, Social Welfare, and Labor Market Frictions

Brendan Epstein, Ryan Nunn, Musa Orak and Elena Patel

No 1284, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Taking inefficiencies from taxation as given, a well-known public finance literature shows that the elasticity of taxable income (ETI) is a sufficient statistic for assessing the deadweight loss (DWL) from taxing labor income in a static neoclassical framework. Using a theoretical approach, we revisit this result from the vantage point of a general equilibrium macroeconomic model with labor search frictions. We show that, in this context, and against the backdrop of inefficient taxation, DWL can be up to 38 percent higher than the ETI under a range of reasonable parametric assumptions. Externalities arising from market participants not taking into account the impact of changes in their search- and vacancy-posting activities on other market participants can amplify this divergence substantially. However, with theoretical precision, we show how the wedge between the ETI and DWL can be controlled for, using readily observable variables.

Keywords: Elasticity of taxable income; Deadweight loss from taxation; Endogenous amenities; Search frictions; Social welfare (search for similar items in EconPapers)
JEL-codes: H20 J32 (search for similar items in EconPapers)
Date: 2020-06-17
New Economics Papers: this item is included in nep-dge, nep-lma, nep-pbe and nep-pub
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Journal Article: Taxation, social welfare, and labor market frictions (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgif:1284

DOI: 10.17016/IFDP.2020.1284

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