Optimal Redistributive Taxation in a Search Equilibrium Model

This paper characterizes optimal non-linear income taxation in an economy with a continuum of unobservable productivity levels and endogenous involuntary unemployment due to frictions in the labour markets. Redistributive taxation distorts labour demand and wages. Compared to their efficient values, gross wages, unemployment, and participation are lower. Average tax rates are increasing. Marginal tax rates are positive, even at the top. Finally, numerical simulations suggest that redistribution is much more important in our setting than in a comparable Mirrlees-type setting. Copyright 2006, Wiley-Blackwell.