November 1, 1998

Tax reform and the Dutch Labor Market: an applied general equilibrium approach

This paper employs MIMIC, an applied general equilibrium model of the Dutch economy, to explore various tax cuts aimed at combating unemployment and raising labor supply.

MIMIC combines modern labor-market theories, a firm empirical foundation, and a detailed description of Dutch labor-market institutions. We develop a small aggregate model, which contains the core of MIMIC, namely wage setting, job matching, labor supply and labor demand. In addition to illustrating the main economic mechanisms in MIMIC, the small model shows the advantages of employing a larger, more disaggregated model that accounts for heterogeneity, institutional details, and more economic mechanisms.

Targeting in-work benefits at the low skilled is the most effective way to cut economy-wide unemployment but damages the quality and quantity of labor supply. Cuts in social security contributions paid by employers and subsidies for hiring long-term unemployed reduce unskilled unemployment most substantially. Tax cuts in the higher tax brackets boost the quantity and quality of formal labor supply but are less effective in reducing unemployment and in raising unskilled employment and female labor supply.

Keywords: Tax policies; Structural unemployment; Labor supply; Applied general equilibrium model; The Netherlands.

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Lans Bovenberg Read more
Johan Graafland Read more
Ruud de Mooij Read more

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