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Prof. Árpád Ábrahám

European University Institute, Florence, Italy

Author: Árpád Ábrahám

Abstract: The optimal level of tax progressivity, typically, trades off insurance/redistribution and incentives. In most theoretical and quantitative applications, the incentives are with respect to labour supply. This project introduces a new dimension into this problem by endogenizing the process of labour productivity through search frictions and performance pay. In this environment, more progressive taxes provide insurance for earnings changes due to unemployment spells and job-to-job movements but make incentive provision within the firm more costly. Our quantitative results show, that the possible insurance gains can be more than offset by the changes in long-term wage contracts offered by the firms. This implies that keeping the wage process exogenous can lead to misleading conclusion when we study the optimal level of tax progressivity analytically or quantitatively.

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