Progressive Income Taxation and Minimum Wage : Can They Correct Market Failure?

This study explores the compensation structures of labor contracts that are offered by firms hiring workers with private information. Workers can be self-selected at equilibrium by performance-based compensation in addition to performance-invariant compensation (called "wage"). Labor market may not play its role of placing labor force to firms as Pareto efficient equilibrium contracts fail to exist due to information asymmetry. In case of market failure, wage floor (such as minimum wage law) becomes an institutional remedy that restores an equilibrium in the market. Alternatively, a progressive income tax policy can be employed to rectify the market failure. It is markedly interesting to find that measures that are usually thought of as promoting equity also contribute to rectification of market failure. It is entirely encouraging to make this case in the sense that equity-enhancing measures could go together with efficiency.