Optimal income taxation with endogenous participation and involuntary unemployment

This paper characterizes the optimal redistributive taxation when individuals are heterogeneous in two exogenous dimensions: their skills and their values of non-market activities. Matching frictions on labor markets generate involuntary unemployment. Wages, labor demand and participation are endogenous. When the government has a Maximin objective and observes only wage levels, we show that the distribution of the elasticity of participation is key. If this elasticity decreases with the skill level, at the optimum, the average tax rate is increasing, marginal tax rates are positive everywhere, while wages and participation rates are distorted downwards compared to their laissez faire values.