Scandinavian Working Papers in Economics

Umeå Economic Studies,
Umeå University, Department of Economics

No 829: Optimal Tax Progression: Does it Matter if Wage Bargaining is Centralized or Decentralized?

Thomas Aronsson () and Magnus Wikström ()
Additional contact information
Thomas Aronsson: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden
Magnus Wikström: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden

Abstract: We study how the optimal use of labor income tax progression depends on whether the wage bargaining system is decentralized or centralized. Assuming a nonlinear labor income tax and an unrestricted profit tax, we show that a Utilitarian government is able to implement the first best resource allocation with a zero marginal labor income tax rate under decentralized wage bargaining, whereas centralized bargaining typically implies a progressive tax as well as unemployment. However, if the government and a (central) wage-setter bargain over wage formation and public policy, the resulting equilibrium is characterized by full employment and a zero marginal tax rate.

Keywords: Optimal taxation; tax progressivity; wage bargaining; corporatism

JEL-codes: H21; H23; J51; J52

21 pages, June 20, 2011

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