Eventi del
22 2018 12:30
Sala riunioni 5.e4.sro4 - Via Roentgen, 1
Macroeconomics Seminar Series
Generalized Compensation Principle
Nicolas Werquin (Toulouse School of Economics)
Abstract
We generalize the classic concept of compensating variation and the welfare compensation principle to a general equilibrium environment with distortionary taxes. We derive in closed-form the solution to the problem of designing a tax reform that compensates the welfare gains and losses induced by an arbitrary economic disruption. The partial equilibrium compensation consists of adjusting the average tax rate to exactly cancel out the initial wage disruption. This is because, by the envelope theorem, individual welfare is affected only by the average tax rates, and not the marginal tax rates. In general equilibrium, the compensating tax reform features three primary modifications to this benchmark. First, the relevant wage disruption that needs to be compensated requires accounting for the endogenous wage adjustments induced by the initial shock (i.e., the local labor demand spillovers). The other two effects arise because the marginal tax rates, in general equilibrium, impact wages, and hence individual utility, despite the envelope theorem. The “progressivity” effect requires adjustments to the tax code that counteract the welfare effects implied by the decreasing marginal product of each skill's labor. This leads to exponentially decreasing or increasing taxes on incomes below those of the disrupted agents at a rate given by the ratio of the elasticity of labor supply and the elasticity of labor demand. The “compensation of compensation” effect requires adjustments that counteract the welfare effects implied by the complementarities between skills in production. This leads to an inductive procedure featuring compounding rounds of iterative compensation. While we provide a closed form expression for this effect in the general model, in the special case of a CES production function it reduces to a remarkably simple uniform shift of the marginal tax rates. Finally, we derive a closed form formula for the fiscal surplus of the wage disruption and the compensating tax reform, thus generalizing the traditional Kaldor-Hicks criterion.