WAGE BARGAINING, LABOR-TAX PROGRESSION, AND WELFARE

This paper analyzes the effect of labor-tax progression on employment and welfare in an economy with a unionized labor market. The governmen t influences wage bargaining through its tax policies. Wages can be re duced by increasing the marginal labor-tax rate. If there are no restr ictions on profit taxation, a first-best optimum with full employment is realized; this first-best optimum can always be implemented by a pr ogressive tax schedule. If profit taxation is restricted, unemployment may arise. For this case, we show that the welfare-maximizing degree of tax progression is influenced by a variety of factors, in particula r the wage elasticity of labor demand, the distribution of bargaining power, and the existence of unemployment benefits. Examples are given for both progressive and regressive tax structures. Comparative-static analysis reveals that a decline in union bargaining power, an increas e in unemployment benefits, and an increase in the overall work force reduce the efficient degree of tax progression.