Strategic fiscal revaluation or devaluation: why does the labor wedge matter?

Francois Langot and Matthieu Lemoine

Working papers from Banque de France

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. (search for similar items in EconPapers)
JEL-codes: D51 F42 H21 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2014
New Economics Papers: this item is included in nep-eec and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:516

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