Taxes, Subsidies and Equilibrium Labour Market Outcomes

35 Pages Posted: 21 Oct 2001

See all articles by Dale T. Mortensen

Dale T. Mortensen

Northwestern University - Department of Economics; IZA Institute of Labor Economics

Christopher A. Pissarides

London School of Economics & Political Science (LSE); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics; Hong Kong University of Science & Technology (HKUST)

Date Written: October 2001

Abstract

We explore the effects of taxes and subsidies on job creation, job destruction, employment and wages in the Mortensen-Pissarides version of the search and matching equilibrium framework. Qualitative analytical results show that wage and employment subsidies increase employment, especially of low skill workers, and also increase wages. A job creation or hiring subsidy reduces unemployment duration but increases incidence with an ambiguous effect on overall employment. A firing tax has the reverse effects but the same indeterminacy. In the special case of a competitive search equilibrium, in which search externalities are internalized, there is a first best configuration. The results are: no tax on the wage, an employment subsidy that offsets the distortions on the job destruction margin induced by unemployment compensation and employment protection policy, as well as a hiring subsidy equal to the implicit tax on severance imposed by any form of employment protection. The costs of these and other policies are financed by a non-distortionary consumption tax. Computational experiments confirm this ideal also determines the direction in which marginal improvements can be made both in terms of efficiency and in terms of improving low skill worker employment and wage outcomes. wage inequality

Keywords: Employment taxes, employment subsidies, wage taxes, firing tax, hiring subsidy, search and matching, unemployment,

JEL Classification: H23, J31, J64, J68

Suggested Citation

Mortensen, Dale T. and Pissarides, Christopher, Taxes, Subsidies and Equilibrium Labour Market Outcomes (October 2001). Available at SSRN: https://ssrn.com/abstract=287319

Dale T. Mortensen (Contact Author)

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States
847-491-8230 (Phone)
847-491-7001 (Fax)

IZA Institute of Labor Economics

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

Christopher Pissarides

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 7513 (Phone)
+44 20 7831 1840 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

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

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

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