Optimal Fiscal Policy with Labor Selection

88 Pages Posted: 2 Jul 2018

See all articles by Sanjay K. Chugh

Sanjay K. Chugh

University of Maryland

Wolfgang Lechthaler

Institute for the World Economy

Christian Merkl

University of Erlangen-Nuremberg-Friedrich Alexander Universität Erlangen Nürnberg; IZA Institute of Labor Economics

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Abstract

This paper characterizes long-run and short-run optimal fiscal policy in the labor selection framework. In a calibrated non-Ramsey decentralized equilibrium, labor market volatility is inefficient. Keeping fixed the structural parameters, the Ramsey government achieves efficient labor market volatility; doing so requires labor-income tax volatility that is orders of magnitude larger than the "tax-smoothing" results based on Walrasian labor markets, but a few times smaller than the results based on search and matching markets. We analytically characterize selection-model-consistent wedges and inefficiencies in order to understand optimal tax volatility.

Keywords: labor market frictions, hiring costs, efficiency, optimal taxation, labor wedge, zero intertemporal distortions

JEL Classification: E24, E32, E50, E62, E63, J20

Suggested Citation

Chugh, Sanjay K. and Lechthaler, Wolfgang and Merkl, Christian, Optimal Fiscal Policy with Labor Selection. IZA Discussion Paper No. 11600. Available at SSRN: https://ssrn.com/abstract=3205887

Sanjay K. Chugh (Contact Author)

University of Maryland ( email )

College Park
College Park, MD 20742
United States

Wolfgang Lechthaler

Institute for the World Economy ( email )

Düsternbrooker Weg 120
Kiel, D-24105
Germany

HOME PAGE: http://www.ifw-kiel.de/kiel-institute-for-the-world-economy/view?set_language=en

Christian Merkl

University of Erlangen-Nuremberg-Friedrich Alexander Universität Erlangen Nürnberg

Schloßplatz 4
Erlangen, Bavaria 91054
Germany

IZA Institute of Labor Economics ( email )

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

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