Measures to block crowding out boil down to giving the low productivity group some guarantee for work at decent income. Such guarantees can be collective/semi-private arrangements of the Swedish/Japanese type. For the more common mixed economies, the guarantee is market-conforming, and notably consists of tax exemption.
29. Tax basics
Taxes are relevant for the discussion of stagflation at least for the following reasons:
(1) Taxes divert income and thus affect aggregate demand, especially when tax revenues go to benefits and consumption instead of saving and investments.
(2) Taxes are thought to cause forward shifting, i.e. that taxes are shifted into wage costs, which then may cause inflation.
(3) Taxes reduce net wages, and might affect the supply of labour. Statutory marginal rates are thought to have disincentive effects.
(4) If exemption is lower than subsistence, then a higher minimum wage is required. Differential indexation widens the gap.
In the following we will first discuss the relation of social insurance premiums to the economic concept of a tax. Then we regard the common tax structure of OECD countries, where the structure concerns both a statute and the dynamic adjustment policy. We introduce a nonlinear tax function and rules on indexation that captures this structure. We then show the effects of differential indexation, and present our new analysis on marginal rates.
Tax dynamics can be split into two components: the dynamics of the short run - where a local temporal equilibrium is attained using the calculations on the marginals - and the dynamics of the long run - where the locus of possible equilibrium points is shifted by long run effects on the levels of the variables. Both components appear to be equally important for our understanding of the subject. The observations on the long run can be usefully discussed in conjunction with the theoretical developments.