Income Taxation and the Equilibrium Allocation of Labor

Jesper Bagger, Kazuhiko Sumiya (), Mads Hejlesen and Rune Vejlin
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Jesper Bagger: Royal Holloway, University of London
Mads Hejlesen: Aarhus University

No 841, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: We study the impact of labor income taxation on workers' job search behavior and the implications it has for the equilibrium allocation of labor in a complete markets equilibrium on-the-job search model with two-sided heterogeneity, endogenous job search effort and hiring intensity, equilibrium wage formation, and firm entry and exit. By appropriating part of the gain from finding a better paid job, income taxation reduces the return to job search effort, and distorts workers' job search effort, which, in turn, distorts the equilibrium allocation of labor. The model is estimated on Danish matched employer-employee data, and is used to evaluate a series of tax reforms in Denmark in the 1990s and 2000s. We find that these income tax reforms increased aggregate productivity by 2.2% through improved labor allocation, provide a novel structural decomposition of the elasticity of taxable labor income, and to identify a Pareto optimal income tax reform.

Date: 2019
New Economics Papers: this item is included in nep-dge, nep-pbe and nep-pub
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Related works:
Working Paper: Income Taxation and the Equilibrium Allocation of Labor (2018)
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