Optimal taxation and labour wedge in models with equilibrium unemployment

Wei Jiang

Studies in Economics from School of Economics, University of Kent

Abstract: In this paper, we develop heterogeneous agent models with equilibrium unemployment to study the optimal taxation and labour wedge. We find that the the presence of profits plays an important role in the determination of both optimal tax policy and labour wedge. Judd-Chamley optimal zero capital tax result can still hold in the model without profits. The optimal labour wedge is zero in the long run. This results in welfare gains of all agents and there is no conflict of interests between agents. But the Benthamite government chooses to subsidise the capital income in the long run in the model with profits due to the presence of productive public investment. The resulting labour wedge is non-zero which generates welfare losses of workers despite welfare gains of capitalists. The government also faces a trade-off between efficiency and equity in this model.

Keywords: household heterogeneity; equilibrium unemployment; optimal taxation; labour wedge (search for similar items in EconPapers)
JEL-codes: E13 E22 E62 (search for similar items in EconPapers)
Date: 2014-09
New Economics Papers: this item is included in nep-dge, nep-mac, nep-pbe and nep-pub
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