Transcript TAXATION AND UNEMPLOYMENT BENEFITS WITH IMPERFECT GOODS

Taxation and Unemployment Benefits
with Imperfect Goods and Labor Markets
Antonio Scialà
University of Padua
Riccardo Tilli
Sapienza University of Rome
2006 Symposium on Contemporay Labor Economics
Xiamen, december 16-18
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Motivations
•
The 90s have been years of flexibilisation of the labor market in the
main European countries, in order to reduce unemployment.
•
In Italy, there is a lack of unemployment benefit programs able to
adverse the effects of the higher labor turnover generated by
flexibility; however…
•
…public financing of such programs has to take into account EU-SGP
constraints on Government budget
•
In the last few years, there is a large debate about the needs to
liberalize some strategic markets such as public utilities, services and
so on
•
We show that the fiscal effects of liberalization policies could
contribute to finance unemployment benefit programs
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Goal of the Paper
•
The aim of the paper is to study the interactions between wage
taxation, unemployment benefits, and goods market
competition in a theoretical framework where:
– the labor market is characterized by frictions (Pissarides,
2000)
– there is monopolistic competition in the goods market
(Dixit-Stiglitz, 1977)
– Government is subject to a balanced-budget constraint.
•
We evaluate the effects of both more competition in the goods
market and higher unemployment benefits on labor market
equilibrium and equilibrium tax rate.
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Main Results
•
More competition on goods market has a positive effect on
equilibrium unemployment and on the Government budget.
•
The increase of per capita unemployment benefits can be financed
in two ways:
– increasing tax rate
– increasing competition in the goods market
•
The first way can introduce in the economic system further
distortions, with an additional negative effect on unemployment.
•
Alternatively, reforms in the goods market towards a higher degree
of competition can maintain the same level of tax rate and offset the
negative effects on unemployment brought about by the raise of
unemployment benefit.
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Related Literature
• Unemployment effects (Koeniger 2002, Ebell and Haefke
2003, Kugler and Pica 2005, Ziesemer 2005, Xie 2006)
• Rent redistribution effects (Blanchard and Giavazzi 2003)
• Optimal tax progressivity (Sorensen 1999)
• Our model: interactions between goods and labor market
reforms and their effects on PBC
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The Labor Market
• Search and matching model (labor market with frictions).
• Total labor force normalized to 1.
• The matching process is summarized by a well behaved
matching function:
h  h u, v 
increasing in both arguments (vacancies and unemployed) and
homogeneous of degree one.
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 The exit rate from unemployment is given by:
h  u, v 
  m  
u
 The coverage rate of a vacant job is given by:
h  u, v 
 m  
v
  is the ratio between vacant jobs and unemployed workers and
represents a convenient measure of the tightness of the labor
market.
• Exogenous job destruction: idiosyncratic shock on productivity
arrive at constant rate s.
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The Beveridge Curve
• The dynamic of unemployment is given by the difference
between the inflows into and outflows from
unemployment:
u  s 1 u   m   u
• In steady state the Beveridge curve is given by:
s
u
s   m  
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Consumer Preferences
Consumers allocate their consumption according
to Dixit-Stiglitz preferences
Constant elasticity (s) demand function
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 s is a measure of the degree of product market
competition that we use as a policy instrument
“To interpret an increase in s as the result of
deregulation, one should think of our specification of
utility as a reduced form reflecting higher
substitutability among products for whatever reason”
(Blanchard-Giavazzi, QJE 2003, p. 885)
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Profit Maximization
•
•
•
•
Multiple workers firm;
CRS technology, with labor as the unique input;
Entry cost k;
Each firm faces the constant elasticity demand
function of the unique good it produces
(monopolistic competition);
»Price rule: mark up on marginal cost.
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Job Creation
• Profit maximization and symmetric equilibrium determine a
job creation condition:

w  JC  ;s , c




(JC)
• JC represents the level of wage that firms are willing to pay,
and is a decreasing function of , since higher  reduces m()
with an increase in the expected search costs.
• The wage is lower than productivity because of both the finite
value of the demand elasticity of product and the search
externality.
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Nash Bargaining
• The economic activity yields a surplus that is shared
between the two parties by a Nash bargaining.
• The maximization of the geometric average of the surplus
of workers (SW) and firms (SF) weighted with the relative
bargaining power determines the following sharing rule:
b 1  t 
SW 
SF
1 b
where b is the bargaining power of the worker and t is the
tax rate on wages.
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Wage Equation
• Given the sharing rule, the optimal behavior of the
economic agents yields the following wage equation:
w  WE   , t ; b, s ,  , b , c 
       
(WE)
• When θ is high the expected recruiting cost faced by
firms is high, while, conversely, the cost for workers to
wait for the next job offer is low. This implies that
workers can bargain better wages.
• With a higher t, the worker will claim a higher wage in
order to preserve the level of the net wage.
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Government Budget Constraint
• No public deficits are allowed, hence Government faces the following
budget constraint:
t 1  u  w  1  t  u w
• we can express the budget constraint as:
s
t=
s + m( )
(PB)
• As θm(θ) is an increasing function of θ, equation PB states a
decreasing relationship between the tax rate t and the labor market
tightness.
• Higher θ decreases the unemployment rate; as a consequence we
have a reduction of the expenditure for unemployment benefits and,
given t, an increase of the public revenue. Hence, the public budget
balance requires a lower level of t.
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The Equilibrium
• Equilibrium is described by the following equations:
• The wage equation, which is a pseudo labor supply
deriving from the Nash bargaining;
• The job creation, which is a pseudo labor demand
deriving from the profit maximization;
• The government budget constraint;
• The Beveridge curve, which expresses the flows
equilibrium in the labor market.
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
w  JC  ;s , c




*
* *

,
w
,t 

w  WE   , t ; b, s ,  , b , c 
       
t
s
s    m  
Beveridge
Curve
u
 
Y  n  y  1 u
*
*
*
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*
*
Zero
Profit
Condition
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The Equilibrium Tightness and Tax Rate
t
PB
(JC=WE)

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Increasing Product Market Competition
t
B
A
C
PB
(JC=WE)'
(JC=WE)

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• Consider the effect of an increase in the demand elasticity. The
(JC=WE) curve moves up to the right:
– Given t, we have that both the wage that firms are willing to pay and
the one required by the workers increase; the latter increase is
proportionally lower than the former: hence, given t, the "demand
side" wage is higher than the "supply side" one.
– Firms will open a higher number of vacancies, that in turn implies a
higher θ: that implies a lower u (shift from A to B)
• In B, the labor market is in equilibrium (we are on the (JC=WE) curve)
but the public budget is in surplus
• Given , lower tax rate t is required in order to balance the Government
budget.
– The reduction of the tax rate produces a feedback on the bargained
wage because workers will perceive a higher net wage and they will
claim a lower gross wage, with a further positive effect on θ (given
the wage offered by the firm).
• The final result of this process will be a higher equilibrium value of θ
and a lower equilibrium value of t (point C in figure).
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Increasing Unemployment Benefit
t
B
PB'
A
PB
(JC=WE)
(JC=WE)'

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• Consider now an increase in the replacement ratio ρ. This implies a
shift down to the left of the (JC=WE) curve and up to the right of the
PB curve.
• The former effect stands from the fact that, given t, an increase in ρ
enhances the option value of the worker which will claim for a
higher gross wage.
• Consequently, because of the negative effect on profit, firms reduce
vacancies. This leads to a higher level of wage w and a lower level of
tightness θ.
• The shift of the PB curve is due to the fact that, given θ, an increase
in ρ requires a higher tax rate t in order to balance the public
budget.
• A specular process with respect to the one discussed above with
regard to an increase in σ, leads to a lower equilibrium value of θ
and a higher equilibrium tax rate t.
• Looking at the figure, we move from equilibrium A to equilibrium B.
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t
B
C
D
A
PB
(JC=WE)
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
• Suppose that, after the 90s labor market flexibilization,
we are now in point A
• As shown above, an increase in u.b. leads to the
equilibrium B: i.e. we would pay a cost in terms of higher
unemployment
• Liberalization policies could permit
– to avoid an increase in unemployment if we allow
some rise in the tax rate (point C);
– to decrease unemployment if liberalization policies
are incisive enough to keep the tax rate unchanged
(point D)
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Main Conclusions
• Unemployment can be reduced increasing competition in
goods market; however…
• …such reforms may claim for an increase of welfare state
expenditure; then…
• …an appropriate combination of the two policy is
required
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Extensions
• Demand elasticity depending on the number of firms
(Hotelling)
• Tax function with coefficient of residual income
progression (Musgrave and Thin, 1948)
• Workers heterogeneity and ridistibutive effects
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