This paper studies the equilibrium outcomes of levying various types of taxes and subsidies on labor in an equilibrium labor search market. It is shown that despite the existence of labor market frictions, there is tax equivalence between an income tax and a payroll tax, exactly as in a competitive labor market. In addition, it is shown that a proportional subsidy has a non-linear, regressive impact on gross and net wages in equilibrium and hence it increases wage inequality. At the same time, a wage subsidy that guarantees a minimum net income has a dampening effect on wages above the guaranteed minimum since it reduces the degree of competition in the market. Thus, the results indicate that given labor market imperfections, wage subsidies may have some undesirable features.

For a PDF of the full article