Optimal Income Taxation with Endogenous Participation and Search Unemployment

41 Pages Posted: 11 Nov 2008

See all articles by Etienne Lehmann

Etienne Lehmann

CREST; Catholic University of Louvain (UCL) - School of Economic and Social Research (IRES); IZA Institute of Labor Economics

Alexis Parmentier

University of Paris 2 Pantheon-Assas - ERMES; University of Paris 1 Pantheon-Sorbonne - Equipe Universitaire de Recherche en Economie Quantitative (EUREQUA)

Bruno Van der Linden

Université Catholique de Louvain - Institut de Recherches Economiques et Sociales; IZA Institute of Labor Economics

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Abstract

This paper characterizes the optimal redistributive taxation when individuals are heterogeneous in two exogenous dimensions: their skills and their values of non-market activities. Search-matching frictions on the labor markets create unemployment. Wages, labor demand and participation are endogenous. The government only observes wage levels. Under a Maximin objective, if the elasticity of participation decreases along the distribution of skills, at the optimum, the average tax rate is increasing, marginal tax rates are positive everywhere, while wages, unemployment rates and participation rates are distorted downwards compared to their laissez-faire values. A simulation exercise confirms some of these properties under a general utilitarian objective. Taking account of the wage-cum-labor demand margin deeply changes the equity-efficiency trade-off.

Keywords: non-linear taxation, redistribution, adverse selection, random participation, unemployment, labor market frictions

JEL Classification: D82, H21, J64

Suggested Citation

Lehmann, Etienne and Parmentier, Alexis and Van der Linden, Bruno, Optimal Income Taxation with Endogenous Participation and Search Unemployment. IZA Discussion Paper No. 3804. Available at SSRN: https://ssrn.com/abstract=1298247 or http://dx.doi.org/10.1111/j.0042-7092.2007.00700.x

Catholic University of Louvain (UCL) - School of Economic and Social Research (IRES) ( email )

3, Place Montesquieu
1348 Louvain-la-Neuve
Belgium

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Alexis Parmentier

University of Paris 2 Pantheon-Assas - ERMES ( email )

12 Place du Panthéon
Paris, Cedex 5, 75005
France

University of Paris 1 Pantheon-Sorbonne - Equipe Universitaire de Recherche en Economie Quantitative (EUREQUA)

106-112 Boulevard de l'Hopital
Paris Cedex 13, 75647
France

Bruno Van der Linden

Université Catholique de Louvain - Institut de Recherches Economiques et Sociales ( email )

3, Place Montesquieu
Louvain-la-Neuve, 1348
Belgium

HOME PAGE: http://perso.uclouvain.be/bruno.vanderlinden/

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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