Taxes, transfers and employment in an incomplete markets model

The consequences of increases in the scale of tax and transfer programs are assessed in the context of a model with idiosyncratic productivity shocks and incomplete markets. The effects are contrasted with those obtained in a stand-in household model featuring no idiosyncratic shocks and complete markets. The main finding is that the impact on hours remains very large, but the welfare consequences are very different. The analysis also suggests that tax and transfer policies have large effects on average labor productivity via selection effects on employment.

Research Highlights► Taxes have large effects on hours in incomplete markets model. ► Incomplete markets has large effects on welfare implications of taxes. ► Productivity catch-up in Europe may be a statistical artifact.