Optimal Taxation and Redistribution in an OLG Model with Unemployment

This paper concerns redistribution and optimal taxation in an OLG model with two employed ability-types. We assume that the wage rates are determined by bargaining between unions and firms, implying that the equilibrium is characterized by unemployment. The tax instruments are nonlinear taxes on labor income and capital income. We show that the policy instruments that are used to calculate the marginal labor income tax rate for each ability-type give rise to intertemporal tax base effects. As such, dynamic models may provide insights with respect to labor income taxation, which are not easily gained in static models. In addition, since the relationship between the employment and the capital stock implies production inefficiency at the second best optimum, imperfect competition in the labor market may, itself, justify capital income taxation.