Is tax progression really good for employment? A model with endogenous hours of work

Clemens Fuest and Bernd Huber

Munich Reprints in Economics from University of Munich, Department of Economics

Abstract: This paper discusses the effect of tax progression on wage setting and employment in a unionised labour market. Recent contributions to this field argue that tax progression paradoxically enhances employment if wage setting is subject to collective bargaining. In this literature, individual hours of work are usually assumed to be exogenously given. We show that the positive employment effect of tax progression can be generalized to a model with a positive labour supply elasticity of individual workers. However, the wage-moderating effect of tax progression does not unambiguously carry over to a world where the union may fix both wages and individual hours of work. In this framework, the union reacts to tax progression by cutting individual working time. The wage rate, however, may decrease or increase. If the wage rate increases, the number of employed workers may decline despite the reduction in hours of work.

Date: 2000
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Published in Labour Economics 1 7(2000): pp. 79-93

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