Labour Taxes, Market Size, and Productivity Growth

Abstract

How do changes in labour taxes affect innovation and aggregate productivity growth? To answer this question, we propose a quantitative, general equilibrium growth model featuring product and quality innovation with endogenous market structure, estimate its parameters, and provide empirical validation for the propagation mechanism of labour tax changes. We find that a temporary cut in flat-rate labour taxes produces a growth acceleration in aggregate productivity, permanently increasing the path of real GDP per capita. Moreover, such permanent gains are sizable even without long-run growth effects.