Taxes, subsidies and equilibrium labor market outcomes
AuthorMortensen, Dale T.
Pissarides, Christopher A.
PublisherCambridge University Press
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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. © Russell Sage Foundation 2003 and Cambridge University Press, 2009.