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Taxation, social welfare, and labor market frictions

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  • Epstein, Brendan
  • Nunn, Ryan
  • Orak, Musa
  • Patel, Elena

Abstract

Taking taxation inefficiencies as given, a well-known public finance result is that in partial equilibrium the elasticity of taxable income (ETI) is a sufficient statistic for the deadweight loss (DWL) from labor income taxation. We revisit this result using a general equilibrium macroeconomic framework with labor search frictions. Our theory parses out the extent to which search frictions in and of themselves can distort the DWL-ETI relationship. Numerical analysis suggests that DWL is nearly 10 percent above the ETI given search frictions, only. Accounting for externalities can drive this figure up to about 20 percent, and accounting unemployment benefits can increase this number up to nearly 40 percent. Parsing out these effects both analytically and quantitatively yields novel results that contribute jointly to the public finance and macroeconomic literatures.

Suggested Citation

  • Epstein, Brendan & Nunn, Ryan & Orak, Musa & Patel, Elena, 2023. "Taxation, social welfare, and labor market frictions," European Economic Review, Elsevier, vol. 151(C).
    • Handle: RePEc:eee:eecrev:v:151:y:2023:i:c:s001429212200232x
    DOI: 10.1016/j.euroecorev.2022.104352
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    More about this item

    Keywords

    Elasticity of taxable income; Deadweight loss; Endogenous amenities; Labor search; Macroeconomic welfare;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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