IZA DP No. 4544: Impacts of Labor Taxation with Perfectly and Imperfectly Competitive Domestic Labor Markets under Flexible Outsourcing
published in: Thomas J. Sargent and Jouko Vilmunen (eds.): Macroeconomics at the Service of Public Policy, Oxford University Press, 2012, 186-214
What are the impacts of labor tax reform on wage setting and employment to keep the relative tax burden per low-skilled and high-skilled workers constant in the case of heterogenous domestic labor markets, i.e. imperfect competition in low-skilled labor and perfect competition in high-skilled labor in the presence of outsourcing? A higher degree of tax progression by raising the wage tax and the tax exemption for the low-skilled workers will decrease the wage rate and increase labour demand of low-skilled workers, whereas it will decrease (increase) employment of high-skilled workers in CES utility function when the elasticity of substitution between consumption and leisure is higher (lower) than one. A higher degree of wage tax progression for the high-skilled worker will have no effect on the high-skilled wage in the presence of CES and C-D utility function so this will have no total employment effects.