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Taxes, subsidies and equilibrium labor market outcomes

By Dale T Mortensen and Christopher Pissarides


We explore the effects of taxes and subsidies on job creation, job destruction, employment, and wages in the Mortensen-Pissarides version of the search and matching equilibrium framework. Qualitative analytical results show that wage and employment subsidies increase employment, especially of low skill workers, and also increase wages. A job creation or hiring subsidy reduces unemployment duration but increases incidence with an ambiguous effect on overall employment. A firing tax has the reverse effects but the same indeterminacy. In the special case of a competitive search equilibrium, the one in which search externalities are internalized, there is a first best configuration: no tax on the wage, an employment subsidy that offsets the distortions on the job destruction margin induced by unemployment compensation and employment protection policy, and a hiring subsidy equal to the implicit tax on severance imposed by any form of employment protection, with the costs of these and other policies financed by a non-distortionary consumption tax. Computational experiments confirm this ideal also determines the direction in which marginal improvements can be made both in terms of efficiency and in terms of improving low skill worker employment and wage outcomes

Topics: HD Industries. Land use. Labor
Publisher: Centre for Economic Performance, London School of Economics and Political Science
Year: 2001
OAI identifier:
Provided by: LSE Research Online

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