Labor Taxation in Search Equilibrium with Home Production.

Conventional models of equilibrium unemployment typically imply that pro-portional taxes on labor earnings are neutral with respect to unemployment as long as the tax does not affect the replacement rate provided by unem-ployment insurance, i.e., unemployment benefits relative to after-tax earn-ings. When home production is an option, the conventional results may no longer hold. This paper uses a search equilibrium model with home pro-duction to examine the employment and welfare implications of labor taxes. The employment effect of a rise in a proportional tax is found to be negative for su¢ciently low replacement rates, whereas it is ambiguous for moderate and high replacement rates. Numerical calibrations of the model indicate that employment generally falls when proportional labor taxes are raised. Progressive labor taxes increase labor market tightness but have ambiguous e¤ects on search e¤ort and employment. The numerical calibrations indicate positive employment effects.