INCOME TAXATION AND JOB-MARKET SIGNALING

This paper develops a model of taxation with asymmetric information be tween the worker and the employer as well as between the worker and th e tax collector. We show that if the informational asymmetry in the la bour market is solved through signaling, implications for taxation are strong. Taxing the signal directly, as well as imposing a progressive tax on income, are both shown to have favourable welfare consequences locally. In contrast to the results obtained for the progressive inco me tax, we show that taxing the signal directly is likely to reduce ot her distortions. The optimal tax fully exploits the possibilities to t ax the signal directly before using progression.