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Working Paper
Fiscal Federalism
Erwin Ooghe

2015/42: Wage policies, employment, and redistributive efficiency

I analyze whether wage policies -like minimum wages and wage subsidies- can add value to an optimal non-linear earnings tax scheme in a perfectly competitive labour market. Jobs in the labour market differ along two margins: intensity (labour effort) and duration (labour hours). Three key results follow. First, even though minimum wages destroy low performance jobs, they increase employment if the minimum wage is binding, but not too high. Second, minimum wages -and wage and labour controls more generally- can enhance redistributive efficiency. The underlying mechanism is their potential to deter mimicking and thus to relax the self-selection constraints in the optimal income tax problem. Third, wage and labour controls become superfluous if a wage-contingent earnings tax scheme –a tax scheme that depends non- linearly on earnings and wages- can be optimally set. Instead, wage and labour subsidies can be optimal in a wage-contingent tax scheme.

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