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

This paper models two kinds 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 financed by a proportional payroll tax. In the small open economy case, with the graduation as specified, we show that both 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, employment is increased for workers whose productivity levels are below or equal to the mean but the interest rate is pulled up, and that may cause employment to fall at productivity levels sufficiently far above the mean. (JEL E24, H22) ∗Paper presented at Conference on Low-wage Employment Subsidies at Russell Sage Foundation in December 1997.