For this model, with supply and demand schedules derived with marginal analysis of utility and profits, there is an important role for statutory marginal tax rates. First best here are lump sum taxes and zero marginal rates.
Figure 19: Statics
Marshallian model for the influence of the tax wedge
There are clear objections to this model:
· It is comparative statics, with homogeneous and flexible labour.
· It concerns any kind of tax, while some taxes are socially desired and generate employment. The model doesn’t distinguish between optimal and suboptimal taxes.
· Empirical research shows that labour supply elasticities are low. Elasticities are higher for partners, but that is less relevant here. People are very much in the position that they have to work for a living, and taxes generally pose no restraint on the availability for the labour market. This means that LS ~ LS1 ~ vertical. (Borjas (1996) shows this graph too.)
· The model does not really allow for unemployment. We might define U = LE° -LE, but LE° is an unobserved variable. Firms and workers react to observed variables, and in those terms there is full employment. Even if labour would be inflexible in this model, then there still would be no involuntary idleness at the net wage earned.
The use of this model thus is limited. Mankiw (1996) correctly presents the model as a ‘tax incidence’ model, and we should be hesitant of other conclusions.
The Simple View however regards this model as a real description of real labour markets, and it thus makes the category mistake of using arguments concerning the income distribution for issues of growth and employment.