RECONSIDERING THE MARGINAL WELFARE COST OF TAXATION

A model with sticky wage rates and involuntary unemployment is used to compute the marginal cost of taxation, and these estimates are compar ed with those obtained from the conventional price-clearing equilibriu m model. Important determinants bf the marginal cost estimates are the response of sticky wages to a tax increase, the elasticity of demand for labour, and the unemployment gap. By contrast, the conventional mo del focuses on the elasticity of labour supply. The different models h ave different implications for efficient tax design. However, the new model generally agrees with the conventional model regarding significa nt efficiency costs of higher taxation.