General Equilibrium Feedback Regarding the Employment Effects of Labor Taxes

Minchul Yum

CRC TR 224 Discussion Paper Series from University of Bonn and University of Mannheim, Germany

Abstract: A higher labor tax rate increases the equilibrium real interest rate and reduces the equilibrium wage in a heterogeneous-agent model with endogenous savings and indivisible labor supply decisions. I show that these general equilibrium adjustments, in particular of the real interest rate, reinforce the negative employment impact of higher labor taxes. However, the representative-agent version of the model, which generates similar aggregate employment responses to labor tax changes, implies that general equilibrium feedback is neutral. The cross-country panel data reveal that the negative association between labor tax rates and the extensive margin labor supply is significantly and robustly weaker in small open economies where the interest rate is less tightly linked to domestic circumstances. This empirical evidence supports the transmission mechanism of labor tax changes for employment in the heterogeneous-agent model.

Keywords: labor income tax; labor supply elasticity; general equilibrium; cross-country panel (search for similar items in EconPapers)
JEL-codes: E21 E24 J21 J22 (search for similar items in EconPapers)
Pages: 31
Date: 2018-12
New Economics Papers: this item is included in nep-dge, nep-lma and nep-mac
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Journal Article: GENERAL EQUILIBRIUM FEEDBACK REGARDING THE EMPLOYMENT EFFECTS OF LABOR TAXES (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:bon:boncrc:crctr224_2018_059

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