A Simple Theory of Optimal Redistributive Taxation withEquilibrium Unemployment

Abstract

We consider an optimal nonlinear income tax problem in a model with search-matching unemployment and where the negotiated pre-tax wage decreases with marginal tax rate but increases with the level of tax. By omitting labor supply Responses, assuming no benefit for the unemployed and an efficient allocation in the absence of tax, we characterize the optimal equity-efficiency trade off. We show that in labor market specific to each interior level of skill, optimal wages and unemployment rates are distorted downwards. Moreover, average tax rate are increasing along the income distribution and marginal tax rate are positive at the top, even when the skill distribution is bonded.