Working Paper: CEPR ID: DP2989
Authors: Dale T. Mortensen; Christopher A. Pissarides
Abstract: We explore the effects of taxes and subsidies on job creation, job destruction, employment and wages in the Mortensen-Pissarides version of the search and matching equilibrium framework. Qualitative analytical results show that wage and employment subsidies increase employment, especially of low skill workers, and also increase wages. A job creation or hiring subsidy reduces unemployment duration but increases incidence with an ambiguous effect on overall employment. A firing tax has the reverse effects but the same indeterminacy. In the special case of a competitive search equilibrium, in which search externalities are internalized, there is a first best configuration. The results are: no tax on the wage, an employment subsidy that offsets the distortions on the job destruction margin induced by unemployment compensation and employment protection policy, as well as a hiring subsidy equal to the implicit tax on severance imposed by any form of employment protection. The costs of these and other policies are financed by a non-distortionary consumption tax. Computational experiments confirm this ideal also determines the direction in which marginal improvements can be made both in terms of efficiency and in terms of improving low skill worker employment and wage outcomes.
Keywords: employment subsidies; employment taxes; firing tax; hiring subsidy; search and matching; unemployment; wage inequality; wage taxes
JEL Codes: H23; J31; J64; J68
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| wage and employment subsidies (J68) | increase in employment levels (J68) |
| wage and employment subsidies (J68) | increase in wages (J38) |
| job creation or hiring subsidies (J68) | reduce unemployment duration (J64) |
| job creation or hiring subsidies (J68) | increase unemployment incidence (J65) |
| job creation or hiring subsidies (J68) | ambiguous overall effect on employment levels (F66) |
| firing tax (H29) | reduce job creation (J68) |
| firing tax (H29) | stabilize employment (J68) |
| first-best configuration in competitive search equilibrium (D51) | no tax on wages (H29) |
| employment subsidies (J68) | offset distortions caused by unemployment compensation and employment protection policies (J65) |