In a high-tax labor market like France, tax reductions are a popular tool to support employment of low-wage workers. The welfare implications of these exemptions go beyond the directly affected. We ask three questions. First, because employment and wages are determined by both supply and demand of labor, what are the equilibrium effects of tax reductions on different workers? Second, since policy-makers' horizons may be short, are short-run effects very different from long-run outcomes? Finally, thirdly, who should benefit from tax reductions? To answer these questions we estimate an equilibrium search-and-matching model with worker and firm heterogeneity based on French administrative data. While a narrowly focused low-wage tax reduction has distributional advantages, it negatively affects productivity by encouraging job creation from low-productivity firms, making it harder for high-productivity workers to find suitable matches. We simulate short-run effects on employment and welfare and find that they may be contrary to the long-run equilibrium effects.
(joint work with Thomas Breda and Luke Haywood)