Monopsony Amplifies Distortions from Progressive Taxes

In this short paper we show that progressive income taxes distort hiring and wages when firms have labor market power. From a firm’s perspective, raising pre-tax wages increases employment by less when taxes are progressive as less of the pre-tax wage is paid to workers. Understanding this when setting wages leads to lower wages and employment at all firms. When firms differ in productivity, progressive taxes also distort the allocation of labor across firms. We characterize this novel monopsony cost of progressivity in a simple monopsony economy and derive efficiency wedges that depend on progressivity. A simple quantification of these wedges points to the possibility that the monopsony cost may be of similar magnitudes to redistribution and insurance benefits.