Tax progression and the wage curve

Abstract

This note derives a model of the wage curve, closely following Phelps (1994) and Campbell and Orszag (1998). Phelps discusses a variety of theoretical bases for a wae curve, the two major competing types being bargaining models and efficiency wage models, though Phelps prefers the term 'incentive wage' models for the latter. The model discussed here is a parametric version of one of Phelps's incentive wage models, developed by Campell and Orszag. The innovation here is to introduce income taxation into the model, with the effect of modifying the wage curve by introducing a measure of tax progressivity into the equation of the wage curve. This result provides a link to the bargaining literature, where the same effect of progression has already been demonstrated.