Government versus Union. The Structure of Optimal Taxation in a Unionized Labor Market

This paper analyses optimal taxation with an imperfect labor market. Unemployment results from the market power of a monopoly union that determines the wage unilaterally. The government provides a public good and raises revenue by taxing rent, labor and capital income. Labor is immobile while capital is internationally traded. This paper focuses on the interaction between government and union. The Nash equilibrium is compared with the alternative of the Stackelberg leadership of the government. While the structure of the game has only a minor impact on the optimal choice of the tax on capital, the tax on labor depends critically on the structure of the interaction. Employment is lower when the government acts as a Stackelberg leader.