Fiscal Policy and Minimum Wage for Redistribution: An Equivalence Result

Abstract

Abstract: In this paper, we derive conditions under which a minimum-wage law combined with anonymous taxes and transfers and an agent-specific tax-transfer scheme are equivalent policies. JEL classification: E62, H21 Key words: redistribution policy, minimum wage, tax-transfer scheme, equivalence result Financial support from Fundacion Ramon Areces and 9/UPV 00035.321-13511/2001 is acknowledged. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility. Please address questions regarding content to Arantza Gorostiaga, Universidad del Pais Vasco, Avenida Lehendakari Aguirre, 83, 48015 Bilbao (Spain), +34 94 601 38 14, arantza.gorostiaga@ehu.es, or Juan Franciso Rubio-Ramirez, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, NE, Atlanta, GA 30309, 404-498-8057, juan.rubio@atl.frb.org. Federal Reserve Bank of Atlanta working papers, including revised versions, are available on the Atlanta Fed's Web site at www.frbatlanta.org. Click Publications and then Working Papers. Use the WebScriber Service (at www.frbatlanta.org) to receive e-mail notifications about new papers. 1. Introduction Many papers in the literature have considered the use of a minimum wage legislation jointly with a tax-transfer scheme to redistribute income among differently productive agents. Moreover, articles such as Allen (1987), Guesnerie and Roberts (1987) and Gorostiaga and Rubio-Ramirez (2004) have shown that minimum wages might be optimal when combined with linear taxes and transfers in a static general equilibrium model. In this paper we prove that any equilibrium allocation attained under a minimum wage law and anonymous taxes and transfers could be implemented through an agent-specific tax-transfer scheme. We also show that the reverse implication is not always true. The equivalence depends on imposing some conditions on the initial agent-specific policy. 2. The basic setup We consider a static general equilibrium model. The economy is populated by two types of agent: low and high productivity households. A proportion [gamma] of households are high-skilled (H), and a proportion 1 - [gamma] are low-skilled (L). This a production economy where a single consumption good is produced. The resource constraint is: [gamma][c.sub.H] + (1 - [gamma])[c.sub.L] = y, (1) where y is the aggregate production, and [c.sub.H] and [c.sub.L] are high-skilled and low-skilled consumption respectively. Firms The available constant returns to scale technology can be represented through the following CES production function: y = F [[gamma](1 - [l.sub.H]), (1 - [gamma])(1 - [l.sub.H])] = [[[phi][[[gamma](1 - [l.sub.H])].sup.[[delta]] + [[(1 - [gamma])(1 - [l.sub.H])].sup.[delta]]].sup.1/[delta]], (2) where [delta] [member of] (0; 1), [phi] > 1, and (1 - [l.sub.H]) and (1 - [l.sub.H]) are high-skilled and low-skilled labor respectively. Firms are price takers and inverse labor demands are: [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (3) [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (4) Households Households in this economy derive utility from consumption and leisure. The utility function U([c.sub.i], [l.sub.i]) is assumed to be strictly increasing and concave in both arguments. Households are endowed with one unit of time which can be devoted to work or leisure, and face the following budget constraint: [c.sub.i] = (1 - [[tau].sub.i])[[omega].sub.i](1 - [l.sub.i]) + [T.sub.i], (5) where [[omega].sub.i] is the wage, [[tau].sub.i] is the income tax rate and [T.sub.i] is a lump-sum transfer. Government We consider two alternative policy schemes: Policy scheme A The redistribution policy is implemented through a minimum wage law that sets a lower bound on low-skilled wages, [[omega]. …