Strategic Fiscal Revaluation or Devaluation: Why Does the Labor Wedge Matter?

42 Pages Posted: 25 Oct 2014

See all articles by François Langot

François Langot

University of Angers - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP); Université du Maine - Groupe d' Analyse des Itineraires et Niveaux Salariaux (GAINS); IZA Institute of Labor Economics

Matthieu Lemoine

Banque de France

Date Written: October 2014

Abstract

Most European countries suffer from a structural weakness of employment and competitiveness. Can an optimal tax system reinforce European countries in this respect? If so, does this long-term policy act as a devaluation or a revaluation? In this paper, we show that fiscal devaluation can be an optimal policy only if the labor wedge is sufficiently large. Indeed, whereas the terms-of-trade externality calls for a fiscal revaluation, i.e. the use of tariffs by "strategic" countries for extracting a rent from their trade partners, a sufficiently large labor wedge calls for employment subsidies, at the heart of a fiscal devaluation. We show that these subsidies must be financed by VAT instead of tariffs, which are less efficient. Finally, in a multi-country world, we show that, if several countries adopt a similar strategy, the impact of this policy is magnified.

Keywords: Optimal taxation, international trade, labor wedge, general equilibrium model

JEL Classification: D51, F42, H21

Suggested Citation

Langot, Francois and Lemoine, Matthieu, Strategic Fiscal Revaluation or Devaluation: Why Does the Labor Wedge Matter? (October 2014). Banque de France Working Paper No. 516. Available at SSRN: https://ssrn.com/abstract=2514221 or http://dx.doi.org/10.2139/ssrn.2514221

Francois Langot

University of Angers - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP) ( email )

Ecole Normale Superieure
48 boulevard Jourdan
75014 Paris
France

Université du Maine - Groupe d' Analyse des Itineraires et Niveaux Salariaux (GAINS) ( email )

72085 Le Mans Cedex 9
France

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Matthieu Lemoine (Contact Author)

Banque de France ( email )

Paris
France

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