Non-Linear Employment Effects of Tax Policy

56 Pages Posted: 24 Jan 2021

See all articles by Domenico Ferraro

Domenico Ferraro

Arizona State University (ASU) - Economics Department

Giuseppe Fiori

Board of Governors of the Federal Reserve System

Date Written: August 11, 2020

Abstract

We study the non-linear propagation mechanism of tax policy in the context of a heterogeneous-agent equilibrium business cycle model with search frictions in the labor market and an extensive margin of employment adjustment. The model exhibits endogenous job destruction and endogenous hiring standards in the form of occasionally-binding zero-surplus constraints. We parametrize the model using U.S. data, including narratively-identified impulse response functions from proxy-SVARs. We find that the dynamic response of the employment rate to a temporary change in the flat-rate tax on labor income is highly non-linear, displaying sizable asymmetries and state-dependence. Notably, the response to a tax rate cut is at least twice as large in a recession than in an expansion.

Keywords: Search frictions; Job destruction; Heterogeneity; Aggregation; Tax policy.

JEL Classification: E12; E24; E32; E62.

Suggested Citation

Ferraro, Domenico and Fiori, Giuseppe, Non-Linear Employment Effects of Tax Policy (August 11, 2020). Available at SSRN: https://ssrn.com/abstract=3740242 or http://dx.doi.org/10.2139/ssrn.3740242

Domenico Ferraro (Contact Author)

Arizona State University (ASU) - Economics Department ( email )

Tempe, AZ 85287-3806
United States

Giuseppe Fiori

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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