Redistribution with labor markets frictions

Abstract

How does the presence of labor market frictions change optimal redistributive policies? Embedding an otherwise standard Mirrlees’ (1971) economy in a directed search environment we show that optimal Utilitarian (and Rawlsian) allocations are characterized by downward distortions in labor supply in both the intensive and extensive margins. After showing that income tax schedules alone cannot implement all constrained efficient allocations, we quantify, for the US economy, the costs of relying on optimal labor income taxes alone.