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Strategic fiscal policies in Europe: Why does the labour wedge matter?

Francois Langot () and Matthieu Lemoine ()

European Economic Review, 2017, vol. 91, issue C, 15-29

Abstract: Most European countries suffer from a structural weakness in employment and competitiveness. Can an optimal tax system reinforce European countries in this respect? In this paper, we show that fiscal competition can be a welfare improving second best solution if the labour wedge is sufficiently large. Indeed, a sufficiently large labour wedge calls for an expansion of the production set in both countries, thus increasing global opportunities. For a small labour wedge, this would not be the case, because the terms-of-trade externality would call for a fiscal policy that exacerbates a non-cooperative behaviour between countries. In a two-country world, we show that the symmetric Nash equilibrium can be Pareto-efficient, if employment subsidies are financed by a consumption tax. This is not the case when the former are financed by tariffs.

Keywords: Optimal taxation; International trade; Labour wedge; General equilibrium model (search for similar items in EconPapers)
JEL-codes: D51 F42 H21 (search for similar items in EconPapers)
Date: 2017
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