Unemployment, Capital Taxation, and (In)determinacy

We introduce, in the Dufourt et al. (2008) model, a welfare/fiscal policy rule through which proportional taxation of capital income is used to finance a given real social security benefit to all workers, either employed or unemployed. Dufourt et al. have considered a segmented asset market economy where unemployment benefits are financed by labor income, and unions may have market power. They have shown that local indeterminacy emerges for a wide and plausible range of parameters due to the unemployment insurance scheme. Here we show that capital income taxation, under our welfare policy rule, promotes local determinacy. In particular, a high enough capital income tax rate is always able to ensure local determinacy, provided the value of the elasticity of substitution between inputs is different from 1. We also show that, at steady state, an increase in the tax rate of capital income, due to a change in the level of the security benefit, is always associated to an increase in employment (lower unemployment), although output increases only if the elasticity of substitution between inputs is lower than 1.