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GENERAL EQUILIBRIUM FEEDBACK REGARDING THE EMPLOYMENT EFFECTS OF LABOR TAXES

Published online by Cambridge University Press:  22 March 2019

Minchul Yum
Minchul Yum*
Affiliation:
University of Mannheim
*
Address correspondence to: Minchul Yum, L 7, 3–5, P09, Department of Economics, University of Mannheim, 68161 Mannheim, Germany. e-mail: [email protected]. Phone: +49 (0)621-181-1853.
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Abstract

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A higher labor tax rate increases the equilibrium real interest rate and reduces the equilibrium wage in a heterogeneous-agent model with endogenous savings and indivisible labor supply decisions. I show that these general equilibrium (GE) adjustments, in particular of the real interest rate, reinforce the negative employment impact of higher labor taxes. However, the representative-agent version of the model, which generates similar aggregate employment responses to labor tax changes, implies that GE feedback is neutral. The cross-country panel data reveal that the negative association between labor tax rates and the extensive margin labor supply is significantly and robustly weaker in small open economies where the interest rate is less tightly linked to domestic circumstances. This empirical evidence supports the transmission mechanism of labor tax changes for employment in the heterogeneous-agent model.

Keywords

Labor Income TaxLabor Supply ElasticityGeneral EquilibriumCross-Country Panel
Type
Articles
Information
Macroeconomic Dynamics , Volume 24 , Issue 8 , December 2020 , pp. 2012 - 2032
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted re-use, distribution, and reproduction in any medium, provided the original work is properly cited.
Copyright
© 2019 Cambridge University Press

Footnotes

I thank Lee Ohanian (co-editor) and two anonymous referees for helpful comments that improved the paper substantially. For constructive suggestions and discussions, I am also grateful to Yongsung Chang, Georg Duernecker, Tom Krebs, Tim Lee, Jim MacGee, Dmitry Matveev, Yongseok Shin, Saverio Simonelli, Takeki Sunakawa, and Jinhee Woo as well as seminar participants at the University of Mannheim, the North American Summer Meeting of the Econometric Society in Philadelphia, 2016 KAEA–KEA International Conference, Asian Meeting of Econometric Society in Kyoto, and 2016 KIPF–KAEA Joint Conference and Kobe University. I gratefully acknowledge funding by the German Research Foundation (DFG) through CRC TR 224. This paper uses data from the Eurosystem Household Finance and Consumption Survey. An earlier version of this paper was titled “On the Employment Effects of Taxes: A General Equilibrium Analysis.”

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