Non-Linear Employment Effects of Tax Policy
56 Pages Posted: 24 Jan 2021
Date Written: August 11, 2020
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.
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