A progressive tax schedule, as it is observed in many developed countries, is usually

justified in terms of redistributive purposes; however, when labor markets are frictional,

progressive taxation has been shown to have a beneficial effect on the unemployment

rate. On the other hand, a more progressive tax schedule discourages individual labor

supply and (precautionary) savings, thus potentially reducing capital accumulation and

total production. In this paper, I take into account the different effects of a progressive

tax and transfer schedule on unemployment, individual labor supply and savings. I

consider the progressive tax and transfer schedule in combination with unemployment

benefits, which are an additional way to provide public insurance against income drop

during unemployment spells. Simple steady state comparisons, based on the utilitarian

welfare criterion, point to the desirability of a tax and transfer schedule with a positive

degree of progressivity, without calling for additional unemployment insurance: in

other words, the welfare criterion calls for a progressive tax schedule combined with

a negative income tax at the bottom of the asset distribution. In terms of modelling

strategy, I start from the workhorse model of Krusell et al. (2010), which combines the

Huggett-Aiyagari framework of heterogeneous agents with matching frictions in the

labor market, and I introduce individual labor supply. I also allow for heterogeneity

in productivity, as in Lifschitz et al. (2016), as well as in preferences for leisure: the

model clarifies that behind the overall welfare effects there is a tension among the low

 

and high productive individuals with respect to the effects of the different policies.