The Distributional Consequences of Tax Reforms Under Market Distortions
27 Pages Posted: 6 Oct 2011
Date Written: September 30, 2011
Abstract
In this paper we examine the importance of imperfect competition in product and labour markets in determining the long-run welfare effects of tax reforms assuming agent heterogeneity in capital holdings. Each of these market failures, independently, results in welfare losses for at least a segment of the population, after a capital tax cut and a concurrent labour tax increase. However, when combined in a realistic calibration to the UK economy, they imply that a capital tax cut will be Pareto improving in the long run. Consistent with the theory of second-best, the two distortions in this context work to correct the negative distributional effects of a capital tax cut that each one, on its own, creates.
Keywords: market imperfections, heterogeneous agents, unemployment, tax reform
JEL Classification: E240, E620
Suggested Citation: Suggested Citation