Optimal Tax Policy with Labor Market Duality
We present a general equilibrium model in which firms can evade social security taxes by offering workers 'atypical' contracts, - a form of tax evasion. We calibrate the model to data from 14 EU countries and the United States and get plausible estimates of the share of 'secondary sector workers' (with atypical contracts) and the size of the underground economy. We use the model to perform quantitative experiments where firms' burden of social security tax is slowly shifted to workers. The effects on welfare and fiscal revenues vary by country but in most cases, reducing firms' tax burden is welfare enhancing and fiscally neutral.