Optimal Redistributive Policy in a Labor Market with Search and Endogenous Participation∗

We study optimal redistributive policies in a frictional model of the labor market. Ex-ante heterogeneous agents choose how much to search in a labor market characterized by a matching technology. We first derive efficiency results and provide policies to decentralize the optimal allocation. We then solve the mechanism design problem of a government with redistributive motives and limited information about agents. A large emphasis is put on the general equilibrium effects of policies on wages and job creation. We show that the optimal policy can be implemented by a non-linear income tax on workers along with an unemployment insurance program. We calibrate our model to the US economy and characterize the welfare gains from the optimal policy and its effects on output, search, wages and unemployment distribution. Our findings suggest that optimal policies often feature a generous unemployment insurance along a negative income tax that efficiently raises the participation and employment of low-income earners.