Taxation of labour, product varieties and skilled–unskilled wage inequality: Short run versus long run

Abstract

In a three-sector general equilibrium model, we examine the impact of a partial tax on labour on skilled–unskilled wage inequality. We find that a tax on labour in industrial sector increases skilled–unskilled wage inequality in the short run and can have the opposite effect in the long run. A tax on labour in the services sector reduces skilled–unskilled wage inequality in both the short run and long run. Furthermore, the introduction of a tax on labour in agricultural sector has no effect on the skilled wage but reduces the unskilled wage. Accordingly, such a tax increases skilled–unskilled wage inequality in both the short run and long run.