Optimal Fiscal Policy with Labor Selection

Sanjay Chugh, Wolfgang Lechthalerz and Christian Merkl
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Wolfgang Lechthalerz: Kiel Institute for the World Economy

No 884, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: This paper characterizes long-run and short-run optimal fiscal policy in the labor selection framework. Quantitatively, the time-series volatility of the labor income tax rate is orders of magnitude larger than the "tax-smoothing" results based on Walrasian labor markets, but is a few times smaller than the results based on search and matching labor markets. To understand these results in terms of model primitives, we develop a welfare-relevant analytic concept of externalities for the selection model, which we label "tightness." This concept of tightness is the source of the decentralized economy's inefficient cross-sectional wage premia between the average newly-hired worker and the marginal newly-hired worker. Compared to the traditional concept of labor-market tightness in the search and matching literature, this new concept of tightness plays a highly similar role, and, like in the matching model, is crucial for understanding efficiency and optimal policy.

Keywords: labor market frictions; hiring costs; efficiency; optimal taxation; labor wedge; zero intertemporal distortions (search for similar items in EconPapers)
JEL-codes: E24 E32 E50 E62 E63 J20 (search for similar items in EconPapers)
Date: 2015-10-25
New Economics Papers: this item is included in nep-dge, nep-lma and nep-mac
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Optimal fiscal policy with labor selection (2018)
Working Paper: Optimal Fiscal Policy with Labor Selection (2018)
Working Paper: Optimal Fiscal Policy with Labor Selection (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:boc:bocoec:884

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