European governments aim to raise labour supply, cut unemployment and, at the same time, maintain social cohesion. Yet, economists have stressed the trade-offs between these objectives. This paper reviews the key policy insights from optimal tax theory to identify options for reform in the tax-benefit system that can potentially improve the equity-efficiency trade-off. Using a comprehensive applied general equilibrium model, we then explore whether reforms along these lines in the actual Dutch tax-benefit system will raise employment without sacrificing equality. The analysis reveals that selective tax relief for elastic secondary earners and low-skilled workers have this potential. A flat income tax structure – possibly combined with a negative income tax – worsens the equity-efficiency trade-off.
Key words: Tax-benefit system; Labour supply; Unemployment; the Netherlands; Applied general equilibrium.
JEL code: D31, D58, H24, J22, J68.

Literature: Ruud de Mooij et al. (2006), Reinventing The Welfare State, CPB Netherlands Bureau for Economic Policy Analysis.