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Why Governments Should Tax Mobile Capital in the Presence of Unemployment

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  • Erkki Koskela
  • Ronnie Schöb

Abstract

This paper shows that a small open economy should levy positive source-based taxes on capital income to fight involuntary unemployment and increase welfare. A revenue-neutral tax reform which increases the capital tax rate and reduces the labour tax rate will induce firms to substitute labour for capital. Even though trade unions might succeed in subsequently increasing the net-of-tax wage rate, such a tax reform will lower marginal cost of production, increase output, and reduce unemployment as long as the labour tax rate exceeds the capital tax rate if elasticity of substitution is above a critical value which is itself below one. Independent of the elasticity of substitution, the government can promote wage moderation by increasing the personal tax credit instead of reducing the labour tax rate.

Suggested Citation

  • Erkki Koskela & Ronnie Schöb, "undated". "Why Governments Should Tax Mobile Capital in the Presence of Unemployment," EPRU Working Paper Series 98-08, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    • Handle: RePEc:kud:epruwp:98-08
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    References listed on IDEAS

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    1. Gordon, Roger H & Bovenberg, A Lans, 1996. "Why Is Capital So Immobile Internationally? Possible Explanations and Implications for Capital Income Taxation," American Economic Review, American Economic Association, vol. 86(5), pages 1057-1075, December.
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    11. repec:bla:ecorec:v:68:y:1992:i:202:p:217-21 is not listed on IDEAS
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    15. Holm, Pasi & Honkapohja, Seppo & Koskela, Erkki, 1994. "A monopoly-union model of wage determination with capital and taxes: An empirical application to the Finnish manufacturing," European Economic Review, Elsevier, vol. 38(2), pages 285-303, February.
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    Citations

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    Cited by:

    1. Wehke, Sven, 2009. "Union wages, hours of work and the effectiveness of partial coordination agreements," Labour Economics, Elsevier, vol. 16(1), pages 89-96, January.
    2. Erkki Koskela & Ronnie Schöb, 2002. "Optimal Factor Income Taxation in the Presence of Unemployment," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 4(3), pages 387-404, July.
    3. Ronnie Schöb, 2003. "The Double Dividend Hypothesis of Environmental Taxes: A Survey," CESifo Working Paper Series 946, CESifo.
    4. Martin Weiss, 2009. "Higher Tax Rates on Labor? Evidence from German Panel Data," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 65(1), pages 73-92, March.
    5. Riedl, Arno & van Winden, Frans, 2012. "Input versus output taxation in an experimental international economy," European Economic Review, Elsevier, vol. 56(2), pages 216-232.
    6. Koskela, Erkki & Schöb, Ronnie, 2007. "How Tax Progression Affects Effort and Employment," IZA Discussion Papers 2861, Institute of Labor Economics (IZA).
    7. Stefan Boeters, 2004. "Green Tax Reform and Employment: The Interaction of Profit and Factor Taxes," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 60(2), pages 222-239, August.
    8. Erkki Koskela & Ronnie Schöb, 2005. "Optimal capital taxation in economies with unionized and competitive labour markets," Oxford Economic Papers, Oxford University Press, vol. 57(4), pages 717-731, October.
    9. Friedrich Breyer & Andreas Haufler, 2000. "Health Care Reform: Separating Insurance from Income Redistribution," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 7(4), pages 445-461, August.

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    More about this item

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • J5 - Labor and Demographic Economics - - Labor-Management Relations, Trade Unions, and Collective Bargaining

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