The effects of the marginal tax rate in a matching model with endogenous labor supply

Abstract

This paper analyzes the effects of the marginal tax rate on unemployment and economic efficiency in a matching model with homogenous agents when wages and working hours are bargained over. I show that the theoretical impact of a higher marginal tax rate on unemployment is ambiguous whatever the instantaneous utility in unemployment i.e. for an utility in unemployment that is either fixed or perfectly indexed on net wages. These results are in sharp contrast with the literature. Numerical simulations applied to France suggest that a higher marginal tax rate generally reduces the unemployment rate but at the expense of lower economic efficiency. The simulations point also out that the relation between the optimal marginal tax rate and the elasticity of labor supply is not monotonic.Matching model; Marginal Tax Rate; Labor supply; Utility in unemployment