Labor market search and the dynamic effects of taxes and subsidies

This paper integrates the search model of unemployment into an intertempora l framework and examines the dynamic effects of a labor income tax, a capit al income tax, an unemployment subsidy, a vacancy subsidy, and an investmen t tax credit. We also compute the marginal deadweight losses associated wit h these policies. The presence of unemployment reduces the relative welfare cost of capital income taxation to labor income taxation. With realistic p arameter values, labor income taxation can even be more costly than capital income taxation. A vacancy subsidy is efficient, self-financed and shares many features with an investment tax credit. An unemployment subsidy is ver y inefficient. Alternative matching and wage determination schemes are anal yzed. (C) 1999 Elsevier Science B.V. All rights reserved. JEL classificatio n: E62; E24; H20.