A Minimum Wage can be Welfare-Improving and Employment-Enhancing

We examine whether minimum wages can fulfill a useful role as part of an optimal nonlinear income tax scheme. In this setting, governments cannot observe household abilities, only their incomes. Redistributing according to income, the government is constrained by a set of incentive constraints. Firms, on the other hand, are able to identify abilities of workers. To exploit that, the government imposes a minimum wage. This will preclude firms …