ABSTRACT
A principal objection to progressive income taxation is that it discourages the supply of effort and labour, and so reduces economic efficiency. Blum and Kalven (1953) set out the traditional arguments for and against progression, including those relating to equity, the benefit principle and macro-economic stabilisation; and for a more recent review see Myles (1995, Chapter 5). The effect of the efficiency loss typically shows up in the form of reduced output, employment and welfare indicators. In the general equilibrium analysis of tax policy it will, therefore, tend to be eliminated in favour of fairly uniform indirect taxes unless the analyst's model permits distributional criteria or, crucially, allows for preexisting distortions. When we introduce non-clearing labour markets, however, the role of progression is much less obvious. Whether unemployment is a byproduct of trade union activity (bargaining models) or missing markets (efficiency wage models) or uncertainty (search models), progression tends to reduce pre-tax wages, and hence stimulate the demand for labour. See for example Hoel (1990), Lockwood and Manning (1993), Goerke (1999) and Sorensen (1999), who also provide a review of the empirical evidence. The net outcome, with reduction in supply but increase in demand for labour, is, therefore, not clear a prion.
