Research
Abstract: What are the implications of imperfect competition in labor markets for optimal labor income taxes? I study this question in an Aiyagari (1994) incomplete-market economy with idiosyncratic risk, borrowing constraints, and the new feature that jobs are differentiated from workers' perspective and firms have wage-setting power. First, under a restricted class of tax policies, as in Heathcote et al. (2017), the government can choose taxes such that the allocation coincides with that implied by optimal taxes in an economy with competitive labor markets. Second, I develop an intuition for this result by studying unrestricted tax policies in a static economy with fixed heterogeneity in skills. In particular, I provide analytical expressions that relate optimal taxes with and without labor market imperfections in this environment to their counterparts in the Aiyagari economy. Third, when calibrated to recent measures of labor market power, optimal taxes in the Aiygari economy increase welfare by 0.2% and output by 0.9% relative to US policy. Optimal taxes are less progressive, and implied markdowns are narrower. Finally, I provide expressions for how equilibrium markdowns are determined by the distribution of workers' assets and productivity, and use these to unpack how changes in borrowing constraints and idiosyncratic risk affect labor market power and hence optimal taxes.
Monopsony Amplifies Distortions from Progressive Taxes, with David Berger, Kyle Herkenhoff, Simon Mongey (AEA Papers and Proceedings forthcoming 2024)
Abstract: In this paper, we show that progressive income taxes distort hiring and wages when firms have labor market power. From a firm's perspective, raising pre-tax wages increases employment by less when taxes are progressive as less of the pre-tax wage is paid to workers. Understanding this when setting wages leads to lower wages and employment at all firms. When firms differ in productivity, progressive taxes also distort the allocation of labor across firms. We characterize this novel monopsony cost of progressivity in a simple monopsony economy and derive efficiency wedges that depend on progressivity. A simple quantification of these wedges points to the possibility that the monopsony cost may be of similar magnitudes to redistribution and insurance benefits.