The Political Origins and Economic Consequences of Taxing Low Wages
Chapter 3: The Economics of Taxing Labour
The aim of this chapter is to investigate the role of the tax mix in the determination of employment and unemployment. It may come as a surprise that the answer is not immediately in the affirmative, but depends on the specific conditions under which a given labour market works. This chapter will therefore provide a survey of the theoretical and empirical economics literature on the link between taxation and (un-)employment.1 It will apply the key insights in this literature to the question of the tax mix and will give some empirical evidence on an aggregate basis. The chapter will not only provide information about normative consequences – what is an optimal tax mix? – but it will also give an account of the economic tradeoffs and restrictions policy-makers face when choosing tax rates. The first section describes the ‘choice menu’ of different theoretical approaches to unemployment, as selecting a particular approach already entails consequences for the link between taxation and the labour market. The second section deals with the overall problem of high total taxation and unemployment. As will become clear, the theories lead to contradictory answers once you allow for imperfectly functioning labour markets. The third section extends the survey to issues of the tax structure: progressivity, tax base, and the insurance component. The fourth section takes a closer look at empirical studies which have been performed on the impact of labour taxation. It will become clear that one of the crucial empirical issues is that the quantitative response of...
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