Effects of Progressive Taxes under Decentralized Bargaining and Heterogeneous Labor

Author: Strand J.

Source: International Tax and Public Finance, Volume 9, Number 2, March 2002 , pp. 195-210(16)

Publisher: Springer

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Abstract:

We consider changes in income tax progressivity in an economy where workers' productivities differ and workers and firms bargain individually over wages. With given employment a pure increase in tax progressivity reduces wages by reducing workers' relative bargaining power. When average taxes also increase, after-tax wages are unambiguously reduced, while the effects on gross wages and firm profitability are ambiguous. We next endogenize employment and firm entry under a uniform worker productivity distribution and the government's only policy instrument is a linear income tax. While a first-best solution then is ruled out, a second-best solution can be implemented using a family of linear tax functions, where a more progressive tax implies a higher tax revenue to the government. We show that the government can increase its tax revenue, and reduce after-tax income differences, without any additional disturbance to allocation.

Keywords: progressive taxes; bargaining; heterogeneous labor

Language: English

Document Type: Regular paper

Affiliations: 1: Department of Economics, University of Oslo, Box 1095, Blindern, 0317 Oslo, Norway jon.strand@econ.uio.no

Publication date: 2002-03-01