Policy Implications

Abstract

What will be the labour market effects of changes in tax rates and of variations in the structure of tax systems if there is unemployment? This is the question which the present study has attempted to answer using models of union-firm interaction and efficiency wage approaches. Since wages generally adjust to variations in tax levels already for a given level of employment in these models, reductions in taxes cannot be predicted to raise employment unambiguously in labour markets characterised by imperfect competition. This statement holds for income taxes, taxes on labour costs and a tax on revenues. In particular, neither variations in the level of income taxes T(w), holding constant the marginal rate T’(w), nor alterations in the level of tax exemption tg or the linear marginal rate t₁ change employment either in a unionised labour market or in an efficiency wage setting in an predictable manner. The same ambiguity with respect to the employment consequences applies to variations in a linear payroll tax S, the tax on revenues z, the general payroll tax >S(wn), and its marginal rate S’(wn). An employment tax σ — or more generally fixed costs of employment — represent somewhat of an exception. Although the effects can, in general, not be signed in models of union-firm interaction, in an efficiency wage framework higher fixed employment costs reduce employment.