Non-Linear Employment Effects of Tax Policy

60 Pages Posted: 5 Jan 2022

See all articles by Domenico Ferraro

Domenico Ferraro

Arizona State University (ASU) - Economics Department

Giuseppe Fiori

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2021

Abstract

We study the non-linear propagation mechanism of tax policy in 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. After parameterizing the model using U.S. data, we find that the dynamic response of employment to a temporary change in the labor income tax 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 as 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 (December 1, 2021). International Finance Discussion Paper No. 1333, Available at SSRN: https://ssrn.com/abstract=3997441 or http://dx.doi.org/10.17016/IFDP.2021.1333

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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