A Simple Theory of Optimal Redistributive Taxation with Equilibrium Unemployment

We consider an optimal nonlinear income tax problem in a model with search-matching unemployment and where the negotiated pre-tax wage decreases with mar-ginal tax rate but increases with the level of tax. By omitting labor supply responsesand assuming bene?t for the unemployed and an e¢ cient allocation in the absenceof tax, we characterize the optimal equity-e¢ ciency trade o¤. We show that in labormarket speci?c to each interior level of skill, optimal wages and unemployment ratesare distorted downwards. Moreover, average tax rate are increasing along the in-come distribution and marginal tax rate are positive at the top, even when the skilldistribution is bonded.