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Nicolas Werquin (Toulouse School of Economics) – "Generalized Compensation Principle", joint work with Aleh Tsyvinski

September 20, 2017 @ 12:15 pm - 1:30 pm
The Microeconomics Seminar: Every Wednesday at 12:15 pm.
Time: 12:15 pm – 1:30 pm
Date: 20th of September 2017
Place: Room 3001.
Nicolas WERQUIN (Toulouse School of Economics) – “Generalized Compensation Principle”, joint work with Aleh Tsyvinski

Abstract: We generalize the classic concept of compensating variation and the welfare compensation principle (Kaldor (1939), Hicks (1940)) to a general equilibrium environment with distortionary taxes. We derive a closed-form solution to the problem of designing a tax reform that compensates the welfare gains and losses induced by any economic disruption, as well as its impact on the government budget. In partial equilibrium, the compensating tax reform consists of adjusting the average tax rate to exactly cancel out the initial wage disruption. In general equilibrium, the compensating tax reform features three departures from this benchmark. First, defining the relevant wage disruption requires accounting for the endogenous wage adjustments induced by the initial shock. Second, the marginal tax rates of the reform that compensates a welfare loss at a given income level should be reduced at a progressive rate that depends on the ratio of the elasticities of labor supply and labor demand. Third, counteracting the welfare effects implied by the complementarities between skills in production requires an inductive procedure to implement compounding rounds of iterated 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.

Marie-Laure Allain (CREST – École polytechnique), Pierre Boyer (CREST – École polytechnique) & Laurent Linnemer (CREST – ENSAE ParisTech)
Lunch registration:
Link (before 17th of September 2017)