Unemployment and the Dynamic Effects of Factor Taxes and Subsidies*

This paper characterizes a dynamic search equilibrium with capital accumulation and examines the dynamic effects of taxes on factor income and subsidies on job search. The paper shows the following results: (i) job vacancies and unemployment are the main variables which respond in the short-run to changes in taxes and subsidies, and their responses generate different dynamics in variables from the standard model with-out unemployment; (ii) the presence of unemployment reduces the welfare cost of capital income taxation and the marginal gain of switching from capital income taxes to labor income taxes; (iii) reducing the replacement ratio increases welfare; (iv) the welfare costs of these policies increase with the bargaining power of labor in wage determination and decrease with the efficiency of job search