April 2001

IZA DP No. 287: Efficiency Properties of Labor Taxation in a Spatial Model of Restricted Labor Mobility

published in: Regional Science and Urban Economics, 2002, 32 (4), 447-473

We examine the efficiency properties of labor taxation. A spatial model of an economy is introduced whose key feature is a new approach to restricted labor mobility. We characterize the efficient allocation of labor and properties of a decentralized equilibrium. An efficient allocation of labor can be compatible with marginal productivity differentials stemming from binding mobility restrictions. We investigate two scenarios of labor taxation (firm-specific taxes and country-specific taxes) and in both setups we give a complete characterization of the cases for which there is scope for redistribution without affecting effciency. Finally, we discuss the applicability of our model in the context of the place of employment and place of residence principle of taxation.