Abstract
The impact of payroll taxes on unemployment and welfare are examined in a model with household production and union–firm wage bargaining. The analysis shows that unemployment typically falls as the payroll tax rate in the market sector for household substitutes (the service sector) is reduced. This holds even when the payroll tax rate in the non‐service sector is raised in order to maintain a balanced government budget. Welfare improves with a reduced‐service‐sector payroll tax rate only if unions are equally strong and firms are equally labour intensive across the sectors. JEL classification: E24; H21; J22; J51
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