The structure of labour taxation and unemployment in efficiency wage models

Abstract

We use an efficiency wage framework to analyze tax reforms that leave the tax wedge unaffected both in the case of constant and endogenous outside options. An increase in the wage tax rate and a reduction of the payroll tax such that the ratio of gross wage rate to net-of-tax wage remains constant, does not affect the labour market allocation. But an increase in the wage tax rate and a reduction of the payroll tax such that the sum of the tax rate remains unaffected, lowers employment and in the long-run Nash equilibrium with endogenous outside option this policy reform also lowers effort.