Employment Effects of Progressive Taxation in a Unionised Economy

Daniela Sonedda

No 166, Royal Economic Society Annual Conference 2002 from Royal Economic Society

Abstract: One of the main arguments against a public finance solution to unemployment is that, at least in the long run, the tax burden is passed onto labour. This paper presents a general equilibrium model on the relation among tax progressivity, wage setting and employment where changes in labour taxation affect the labour market equilibrium. It is shown that the relation of interest depends on the initial level of taxation and on the labour tax parameter allowed to vary (marginal-average, personal income-payroll taxes). On the basis of a calibration exercise for Italy and the US, the qualitative analysis of the model is supported and the effects are quantified. In particular, larger employment effects are determined by a reduction in both the average (personal income\payroll)\ tax rates. Taking as a benchmark for our policy experiment the actual fiscal reform during the period 1978-97, variations in the employment rate implied by our model are quite close to those empirically observed.

Date: 2002-08-29
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