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Taxation and Unemployment in Models with Heterogeneous Workers

Taxation and Unemployment in Models with Heterogeneous Workers

by Iourri Manovskii, Marcus Hagedorn and Sergiy Stetsenko

Published in Review of Economic Dynamics in 2016

Abstract

We introduce ex-ante heterogeneity between workers and two technology shocks, neutral and investment-specific, as the driving forces into the basic Mortensen–Pissarides search and matching model. The calibrated model is simultaneously consistent with a strong response of labor market variables to cyclical fluctuations in productivity and a weaker response to changes in taxes found in cross-country data. The model also matches the evidence that countries with higher tax rates have higher aggregate productivity, lower skill premia, and higher unemployment rates among both high- and low-skilled workers. The key mechanism that allows us to achieve these results is that aggregate and group-specific productivities are endogenous and respond to changes in tax policy.

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