Taxation and Unemployment Benefits with Imperfect Goods and Labor Markets

We consider a model in which the labor market is characterized by search frictions and there is monopolistic competition in the goods market. We introduce proportional income taxation and unemploy-ment benefits with Government balanced budget constraint. Then, we evaluate the effects of both more competition in the goods mar-ket and higher unemployment benefits on labor market equilibrium and equilibrium tax rate. We show that more competition has a posi-tive effect on equilibrium unemployment and the Government budget. Higher unemployment benefits can be financed either by higher tax rate or increasing goods market competition. Liberalization policies could permit: a) to avoid an increase in unemployment if we allow some rise in the tax rate; b) to decrease unemployment if they are incisive enough to keep the tax rate unchanged