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Income Taxation and the Equilibrium Allocation of Labor

Jesper Bagger, Mads Hejlesen, Kazuhiko Sumiya and Rune Vejlin ()
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Jesper Bagger: Royal Holloway and the Dale T. Mortensen Centre
Mads Hejlesen: Department of Economics and Business Economics, Aarhus University, Denmark
Kazuhiko Sumiya: Royal Holloway

Economics Working Papers from Department of Economics and Business Economics, Aarhus University

Abstract: We study the impact of labor income taxation on workers' job search behavior and the implications it has for the equilibrium allocation of heterogenous workers across heterogenous firms. The analysis is conducted within 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. In a nutshell, 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, to provide new insights into the elasticity of taxable labor income, and to identify a Pareto optimal income tax reform.

Keywords: Labor reallocation; Income taxation; Tax reforms; Worker heterogeneity; Firm heterogeneity; Matched employer-employee data (search for similar items in EconPapers)
JEL-codes: H20 J30 J64 J63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-lab, nep-pbe and nep-pub
Date: 2018-08-20
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Handle: RePEc:aah:aarhec:2018-06