Working Paper: CEPR ID: DP3446
Authors: Jan Boone; A. Lans Bovenberg
Abstract: In order to explore the optimal taxation of low-skilled labour, we extend the standard model of optimal non-linear income taxation in the presence of quasi-linear preferences in leisure by allowing for in-voluntary unemployment, job search, an exogenous welfare benefit, and a non-utilitarian social welfare function. In trading of more low-skilled employment against more work effort of higher skilled workers, the government balances distortions on the search margin with those on work effort. Positive marginal tax rates at the bottom may help to encourage job search if this search is taxed on a net basis. Lower welfare benefits and search costs tend to reduce marginal tax rates throughout the skill distribution.
Keywords: Bunching; Labour Market Search; Low-Skilled Labour; Nonlinear Taxation; Participation Margin; Social Assistance; Unemployment
JEL Codes: H21; J64; J65
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Positive marginal tax rates at the bottom of the income distribution (H31) | Encourage job search among unskilled workers (J68) |
| Lower welfare benefits and search costs (I38) | Reduce marginal tax rates across the skill distribution (H31) |
| High marginal tax rates (H29) | Unskilled agents may drop out of the labor force entirely (F66) |
| Higher welfare benefits (I38) | Increased unemployment among unskilled workers (F66) |
| Optimal tax policy must account for dynamics of employment incentives and welfare support (H31) | Effectively balance employment incentives and welfare support (J68) |