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Is Tax Progression Good for Employment? Efficiency Wages and the Role of the Prereform Tax Structure

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Within an efficiency-wage framework, we study the effects of two revenue-neutral tax reforms that change the progressivity of the labor tax system. A revenue-neutral increase in both the wage tax and the tax exemption and a revenue-neutral change in the composition of labor taxation towards the tax with the smaller base will lead to the same results: they moderate wages, workers' effort, effective labor input, and aggregate output. Whether employment rises or falls, however, depends in both reforms on the magnitude of the prereform total tax wedge. We show that this ambiguity stems from the effect tax progression has on the marginal revenue changes of tax and tax exemption changes. This budgetary effect determines the result in the same way in both tax reforms and turns out to be the crucial force in determining the effect the degree of tax progressivity has on employment.
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Keywords: EFFICIENCY WAGES; STRUCTURE OF LABOR TAXATION; TAX PROGRESSION

Document Type: Research Article

Publication date: 01 March 2009

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  • As one of the world's oldest professional journals in public finance, founded in 1884, FinanzArchiv (FA) publishes original work from all fields of public economics which are of interest to an international readership, e.g. taxation, public debt, public goods, public choice, federalism, market failure, social policy, and the welfare state. Special emphasis is on high-quality theoretical and empirical papers on current policy issues.

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    FA is listed in the Social Science Citation Index (SSCI), in Current Contents/Social and Behavioral Sciences, in Econ Lit, in the Journal of Economic Literature, in IDEAS and RePEc and in the International Bibliography of the Social Sciences.

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