Passing the burden: corporate tax incidence in open economies

various types of labor and capital. In order to allow for different elasticities of substitution
between types of labor and capital, I use a nested CES production function. I follow the direction
of Fallon and Layard (1975) who find that equation (2) is the most accurate specification for a
two-level nested CES production function where L1 is skilled-labor and L2 is unskilled labor.
The production function in equation (2) assumes that the elasticity of substitution between
capital (K) and unskilled labor (L2) is equal to the elasticity of substitution between skilled (L1)
and unskilled labor. This elasticity of substitution is defined as 1/ (1-ρ). The elasticity of

substitution between skilled labor and capital is defined as 1/ (1- θ). If ρ > θ, then skilled labor is
more complementary with capital than unskilled labor.

In order to coincide with my data, I augment this production function in order to allow
three types of labor: high-skill, medium-skill, and low-skill, as seen in equation (3). I assume that
L1 is high-skill labor, L2 is middle-skill labor and L3 is low-skill labor because past literature
suggests that this specification most accurately describes the data. However, this assumption is
not needed for the results to hold. High-skill labor is the most complementary with capital,
followed by middle-skill if β > γ > θ. However, this production function does not assume that L1
is most complementary with capital; this is determined by the values of β, γ, and θ. The function
does assume that the elasticity of substitution between K and L2 is equal to the elasticity of
substitution between L1 and L2.

л
γ

b [aK^θ + (1 - a)L^θθ ]^θ + (1 - b)L^γ

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