Tax Policy in the Presence of Migration and Urban Unemployment

Two pervasive features of most less developed countries (LDCs) are the presence of persistent urban unemployment and rural to urban migration, and these phenomena are important for an analysis of taxes and prices: any model that attempts to describe an LDC economy must at least be consistent with the presence of urban unemployment. Thus, the case is weak for an exclusive use of the neoclassical model (the form typically exposited in public finance textbooks in which all markets clear and in which there is no unemployment). Most models attempting to incorporate urban unemployment begin with the hypothesis that urban wages are higher than the market-clearing level, but they do not explain why wages are high and how wages are determined. Earlier chapters have described alternative mechanisms for determining urban wages and employment, and shown that taxation policies may well have an effect on these, and how this effect, in turn, affects the analysis of taxation policies. A further effect is that taxation policies may affect the nature of migration between the rural and the urban sectors, so a complete analysis of tax policy must take into account its induced effects on migration; these issues are addressed in this chapter.