Redistribution with labor market frictions

Abstract

How should search frictions in the labor market affect distributive policies? Can we assess current real-world policies? After building a framework for answering these questions we show that any constrained efficient allocation must satisfy the following set of testable restrictions: i) earnings and employment probability must be co-monotone, ii) wedges on taxable income and employment probability must have the same sign; and; iii) wedges at the bottom of the distribution of income should be positive. Labor income tax schedules and unemployment benefits are shown not to suffice for implementing constrained efficient allocations. Firms can nonetheless be provided incentives to generate the efficient supply of vacancies using informationally feasible tax instruments. We devise a method for the quantitative assessment of inefficiency, calibrate our model to the U.S. economy, and find that it is possible to increase government revenues by 3.48% while preserving everyone’s utility