Optimal Income Taxation in Unionized Labor Markets

Abstract

This paper extends the Diamond (1980) model with labor unions to study optimal income taxation and to analyze whether unions can be desirable for income redistribution. Unions bargain with firms over wages in each sector and firms unilaterally determine employment. Unions raise the efficiency costs of income redistribution, because unemployment benefits and income taxes raise wage demands and thereby generate involuntary unemployment. Optimal unemployment benefits and optimal income taxes are lower in unionized labor markets. We show that unions are socially desirable only if they represent (low-income) workers whose participation is subsidized on a net basis. By creating implicit taxes on work, unions alleviate the labor-market distortions caused by income taxation. Numerical simulations demonstrate that optimal taxes and transfers are much less redistributive in unionized labor markets than in competitive labor markets.

Is a Minimum Wage an Appropriate Instrument for Redistribution?

“… See also Hummel and Jacobs (), who demonstrate that labour unions can be desirable for income redistribution to alleviate the distortions of excessive labour participation caused by participation subsidies. …”

Optimal Redistributive Income Taxation and Efficiency Wages*

“…Albeit small by comparison, a body of literature on optimal redistributive taxation under unemployment has gradually evolved during the latest decades, in which the incentives underlying an optimal tax policy partly differ from those following under perfect competition. The major mechanisms generating unemployment in these studies are trade‐union wage formation (e.g., Aronsson and Sjögren, 2003, 2004; Aronsson et al ., 2009; Hummel and Jacobs, 2018), minimum wages (Marceau and Boadway, 1994), and search frictions (Lehmann et al ., 2011). Although fundamentally different, a common denominator is a policy incentive to reduce the level of unemployment, which is likely to result in higher marginal tax rates than under perfect competition.…”

Equity and efficiency in rationed labor markets

“…This paper is related to a small strand of the literature that considers optimal taxation in the presence of involuntary unemployment. These studies consider different sources of unemployment, ranging from minimum wages (e.g., Allen, 1987;Guesnerie and Roberts, 1987;Marceau and Boadway, 1994;Boadway and Cuff, 2001;Lee and Saez, 2012;Gerritsen and Jacobs, 2015), to union-set wages (e.g., Sørensen, 1999;Aronsson and Sjögren, 2004;Hummel and Jacobs, 2016), to downward rigid wage floors (e.g., Landais, Michaillat, and Saez, 2013;Kroft et al, 2015). Most of these studies consider identical agents so that the efficiency of labor rationing plays no role of significance.…”