1996 Reports

Low-Wage Employment Subsidies in a Labor Turnover Model of the 'Natural Rate'

Hoon, Hian Teck; Phelps, Edmund S.

This paper studies two kind of wage subsidy in a model of the natural rate having a continuum of workers ranked by their productivity -- a flat wage subsidy and a graduated wage subsidy, each program financed by a proportional payroll tax. We show that in the model's small open economy version, both subsidy schemes expand employment throughout the distribution; for those whose productivity is sufficiently far below the mean, take home pay is unambiguously up, though the tax financing lowers take home pay at the mean and above. For any particular class of workers paid the same amount of the wage subsidy under the two plans, the graduated plan expands employment more. In the closed economy case, the interest rate is pulled up, and employment is increased for workers whose productivity levels are below or equal the mean. A hiring subsidy is also studied.