International Trade and Unemployment by Marco de Pinto

Author:Marco de Pinto
Language: eng
Format: epub
Publisher: Springer Berlin Heidelberg, Berlin, Heidelberg

3.4.3 The Payroll Tax

Next, we consider the introduction of the payroll tax with and . Concerning the employment of active workers first, raises the marginal costs of the representative firm. The optimal response is clearly an increase in prices, which leads to a decrease in the FRW, (see (3.45)). The rise in prices dampens the demand for each variety, and thus production and employment fall (see (3.50)):

The employment reduction leads to a one-to-one decrease in aggregate output and welfare (see (3.52)).

Like the former policy instruments, the FS remains constant. Thus, ϕ ∗  and are unaffected just as a  ∗  and the number of long-term unemployed persons. The economic intuition behind this result is as follows. On the one hand, the number of active firms in the market declines, M ∕ M ′  < 1 (see (3.53) and ). The demand reduction mentioned above yield a decrease in the firms’ net profits implying that the least productive firms are driven out of the market. On the other hand, the decreasing number of firms raises the demand for each variety, revenues and profits of the still active firms increase. Given this outcome, a firm that observes ϕ ∗  in the Melitz lottery can still obtain a zero-profit and thus stay at the market.20

Note that these findings also hold if the government would introduce a tax on firms’ revenues. Due to the mark-up pricing rule, the optimal response of such an increase in marginal costs is a rise in prices. The FRW falls, and thus employment as well as the welfare unambiguously decreases.

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