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Flat income taxation, redistribution and labour market performance

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Abstract:

A flat tax rate on labour income has gained popularity in European countries. This article assesses the attractiveness of such a flat tax in achieving redistributive objectives with the smallest distortions to employment. We do so by using a detailed applied general equilibrium model for the Netherlands. The model is empirically grounded in the data and encompasses decisions on hours worked, labour force participation, skill formation, wage bargaining between unions and firms and a wide variety of institutional details. The simulations suggest that the replacement of the current tax system in the Netherlands by a flat rate will harm labour market performance if aggregate income inequality is contained. Only flat tax reforms that reduce redistribution will raise employment. This finding bolsters the notions from optimal tax literature regarding the equity-efficiency trade off and the superiority of nonlinear taxes to obtain redistributive goals in an efficient way.

Document Type: Research Article

DOI: https://doi.org/10.1080/00036840802112356

Affiliations: 1: Tinbergen Institute and Netspar and CESifo, Erasmus University Rotterdam, Rotterdam, The Netherlands 2: Tinbergen Institute and Netspar and CESifo, Erasmus University Rotterdam, Rotterdam, The Netherlands,CPB Netherlands Bureau for Economic Policy Analysis, PO Box 80510, 2508 GM, The Hague, The Netherlands 3: CPB Netherlands Bureau for Economic Policy Analysis, PO Box 80510, 2508 GM, The Hague, The Netherlands

Publication date: 2010-10-01

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