Ambiguous effects of tax progressivity - theory and Danish evidence

Recent tax reforms in the OECD area have aimed at reducing the progressivit y of labour income taxation by reducing marginal taxes for given average ta xes. Theory has shown that this reduces employment/production when workers and firms determine wages through bargaining, This paper shows that an oppo site effect arises when both wages and working hours are subject to bargain ing. This may reverse the traditional result and this is especially likely if the bargaining power of workers is low and if labour supply is relativel y elastic. In conclusion, the overall effect of a reduction in progressivit y is ambiguous. The empirical estimates for Denmark indicate that the overa ll effect is negative for blue-collar workers and neutral for white-collar workers. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classifica tion: H24; J42; J51.