Interregional demand for workers and the effects of labour income taxation

We study the short-run impacts of labour income taxation in an aggregate economy of N > 2regions. The distinct regions demand workers. Each region is endowed with one unit of immobile capital. The aggregate economy also has one unit of labour that is mobile across the regions. All regions produce a final good with identical Cobb-Douglas production functions. The price of output is normalized to unity. We perform five tasks. First, we focus on the benchmark case in which no region taxes either capital or labour. We find the equilibrium wage, the allocation of workers across the regions, and the total income of labour and capital. Second, we study the impact of a tax tau on labour income in region 1 when the other N-1 regions do not tax labour income. We ascertain the after-tax return to labour in region 1, the equilibrium wage, and the allocation of labour across the regions. Third, we compute the total income of capital and labour and the tax revenue in region 1. Fourth, we discuss whether workers in region 1 are better off with a tax on labour income. Finally, we comment on the policy implications of our research.