Taxation and Unemployment in Models with Heterogeneous Workers
By Iourii Manovskii, Marcus Hagedorn and Sergiy Stetsenko
Published in Review of Economic Dynamics, 2016
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.