Labor Market Institutions and the Cohesion of the Middle Class

Abstract

We develop a simple model to study how relative wage rigidity affects equilibrium taxation. It is argued that relative wage rigidity, by compressing incomes within the middle class, leads to a lower degree of redistributive conflict within the politically important core of society, even though income inequality may increase for society as a whole. In the model, people vote first on wage rigidity and second on redistributive taxation. The rigid society has a lower tax rate than the flexible one. It is supported by the "middle class" in the first stage, while the poor, the rich and the unemployed suffer from it.

JEL Classification: J31, H23