Redistribution with labor market frictions

We study distributive and insurance policies in frictional labor markets where workers are privately informed about their abilities. The combination of selection and moral hazard constraints demands the use of new tax instruments that are redundant in frictionless labor markets to target vacancy creation. We characterize efficient allocations and derive new optimality conditions on effort and employment probability wedges. Wedges on both effort and vacancy creation are always positive at the bottom of the income distribution. For strong enough distributive motives, the same is true for all but the most productive agents. We devise a method for the quantitative assessment of inefficiencies, calibrate our model to the U.S. economy, and find that it is possible to increase government revenues by 3.48% while preserving everyone's utility.