Labour Tax Reform, Employment and Intergenerational Distribution

A simulation model of an open economy with a unionized labour market is set up to analyze the effects of a labour tax reform which combines cuts in marginal tax rates with measures to broaden the tax base. We find that such a reform will be contractionary and welfare reducing if unions set wage rates with the purpose of maximizing the after-tax income of their members. By contrast, if unions also allow for the disutility of work of their members, the reform will stimulate employment, increase the welfare of all generations, and redistribute welfare in favour of future generations.