Fiscal Devaluation and Structural Gaps
39 Pages Posted: 2 Oct 2014
Date Written: October 2014
The paper characterizes the optimal tax scheme in an open economy with structural inefficiencies on the labor market and on government size. On analytical grounds first, we show that the economy can use fiscal revaluation to exploit the terms of trade externality and to dampen the impact of an excessive public spending. However, if real labor market rigidities are large enough, fiscal devaluation may be desirable. Second, we provide a quantitative assessment of the optimal tax reform using France as the benchmark economy. Our results show that France would benefit more from fiscal devaluation than a economy where the labor market is more flexible, as the US. We also show that the welfare gains from the optimal tax reform crucially depend on the ability of the government to target its optimal size.
Keywords: Consumption tax, payroll tax, Ramsey allocation, labor market search, open economy, public spending
JEL Classification: E27, E62, H21, J38
Suggested Citation: Suggested Citation