Working Paper

Non-Linear Employment Effects of Tax Policy

Abstract: We study the non-linear propagation mechanism of tax policy in a heterogeneous agent equilibrium business cycle model with search frictions in the labor market and an extensive margin of employment adjustment. The model exhibits endogenous job destruction and endogenous hiring standards in the form of occasionally-binding zero-surplus constraints. After parameterizing the model using U.S. data, we find that the dynamic response of employment to a temporary change in the labor income tax is highly non-linear, displaying sizable asymmetries and state-dependence. Notably, the response to a tax rate cut is at least twice as large in a recession as in an expansion.

Keywords: Search frictions; Job destruction; Heterogeneity; Aggregation; Tax policy;

JEL Classification: E12; E24; E32; E62;

https://doi.org/10.17016/IFDP.2021.1333

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2021-12-20

Number: 1333