Scandinavian Working Papers in Economics

Umeå Economic Studies,
Umeå University, Department of Economics

No 953: Optimal Redistributive Income Taxation and Efficiency Wages

Thomas Aronsson () and Luca Micheletto ()
Additional contact information
Thomas Aronsson: Department of Economics, Umeå University, Postal: Department of Economics, Umeå University, S 901 87 Umeå, Sweden
Luca Micheletto: Department of Law, University of Milan, Italy, Dondena Centre, Bocconi University, and CESifo Germany, Postal: Bocconi University, 20136 Milan, Italy

Abstract: This paper integrates efficiency wage setting in the theory of optimal redistributive income taxation. In doing so, we use a model with two skill-types, where efficiency wage setting characterizes the labor market faced by the low-skilled, whereas the high-skilled face a conventional, competitive labor market. There are two types of jobs in this economy; a low-demanding job which can be carried out by everybody, and a high-demanding job which can only be carried out by the high-skilled, meaning that a potential mimicker may either adopt a conventional income-replication strategy or a job-replication strategy. In this framework, we show that the marginal income tax implemented for the high-skilled is negative under plausible assumptions. The marginal income tax facing the low-skilled can be either positive or negative in general, even if employment-related motives for policy intervention typically contribute to an increase in this marginal tax. An increase in the unemployment benefit contributes to relax the binding self-selection constraint (irrespective of the strategy adopted by a potential mimicker), which makes this instrument particularly useful from the perspective of redistribution.

Keywords: Nonlinear income taxation; unemployment benefits; efficiency wages; redistribution

JEL-codes: H21; H42

47 pages, October 3, 2017

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