Department of Economics and Business Economics

Income Taxation and the Equilibrium Allocation of Labor

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We study the impact of labor income taxation on workers' job search behavior and the implications it has for the equilibrium allocation of heterogenous workers across heterogenous firms. The analysis is conducted within a complete markets equilibrium on-the-job search model with two-sided heterogeneity, endogenous job search effort and hiring intensity, equilibrium wage formation, and firm entry and exit. In a nutshell, by appropriating part of the gain from finding a better paid job, income taxation reduces the return to job search effort, and distorts workers' job search effort, which, in turn, distorts the equilibrium allocation of labor. The model is estimated on Danish matched employer-employee data, and is used to evaluate a series of tax reforms in Denmark in the 1990s and 2000s, to provide new insights into the elasticity of taxable labor income, and to identify a Pareto optimal income tax reform.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages75
Publication statusPublished - 20 Aug 2018
SeriesEconomics Working Papers
Number2018-06

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