Working Paper: NBER ID: w4810
Authors: Alberto Alesina; Roberto Perotti
Abstract: In all modern industrial countries, redistributive expenditures are a larger component of the government budget than consumption of goods and services. In this paper, we use a general equilibrium, two- country model with exportables, importables and nontradables to study redistribution across different types of agents in a world characterized by the presence of labor unions and distortionary taxation. We show that an increase in transfers to, say, retirees, financed by distortionary taxation, can generate a loss of competitiveness (defined as an increase in relative unit labor costs for tradable goods), an appreciation of the relative price of nontradables, and a decrease in employment in all sectors of the domestic economy. The same qualitative effects would also obtain in the case of an increase in transfers towards the unemployed even if financed by non-distortionary taxation. Moreover, all these effects of labor taxation depend in a nonlinear way on the degree of centralization of the wage setting process in the labor market. We then estimate the effects of labor taxation on unit labor costs and the relative price of nontradables in a sample of 14 OECD countries. We find considerable empirical support for the model.
Keywords: Welfare State; Competitiveness; Labor Taxation; Redistribution; Fiscal Policy
JEL Codes: H20; H50; J50; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in transfers to retirees (H55) | loss of competitiveness (F69) |
| increase in transfers to retirees (H55) | increase in relative unit labor costs for tradable goods (F16) |
| increase in transfers to retirees (H55) | appreciation of the relative price of nontradables (F16) |
| increase in transfers to retirees (H55) | higher wage pressures from labor unions (J39) |
| higher wage pressures from labor unions (J39) | increase in output prices (E31) |
| increase in output prices (E31) | decrease in employment across sectors (J63) |
| increase in transfers to the unemployed (J65) | loss of competitiveness (F69) |
| increase in transfers to the unemployed (J65) | increase in relative unit labor costs for tradable goods (F16) |
| increase in transfers to the unemployed (J65) | appreciation of the relative price of nontradables (F16) |
| degree of centralization in wage-setting processes (J31) | influence on effects of transfers (F16) |
| 1% increase in labor taxation (H31) | up to 3% increase in unit labor costs (J39) |