Is Tax Progression Good for Employment? Efficiency Wages and the Role of the Prereform Tax Structure

Erkki Koskela and Ronnie Schöb
Authors registered in the RePEc Author Service: Ronnie Schoeb

FinanzArchiv: Public Finance Analysis, 2009, vol. 65, issue 1, 51-72

Abstract: Within an efficiency-wage framework, we study the effects of two revenue-neutral tax reforms that change the progressivity of the labor tax system. A revenue-neutral increase in both the wage tax and the tax exemption and a revenue-neutral change in the composition of labor taxation towards the tax with the smaller base will lead to the same results: they moderate wages, workers´ effort, effective labor input, and aggregate output. Whether employment rises or falls, however, depends in both reforms on the magnitude of the prereform total tax wedge. We show that this ambiguity stems from the effect tax progression has on the marginal revenue changes of tax and tax exemption changes. This budgetary effect determines the result in the same way in both tax reforms and turns out to be the crucial force in determining the effect the degree of tax progressivity has on employment.

Keywords: efficiency wages; tax progression; structure of labor taxation (search for similar items in EconPapers)
JEL-codes: H22 J41 J48 (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (4)

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DOI: 10.1628/001522108X444206

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