Abstract

Tax smoothing is a ubiquitous feature of Ramsey-tax policies in standard macroeconomic models. However, when labor markets are frictional this feature may break down, and parts of the literature instead calls for "extreme labor-tax volatility", questioning the optimality of current tax policies in many western economies (Arseneau and Chugh, JPE, 2012). We revisit this question and show that some of these conclusions are premature. In particular, when the (Ramsey) steady-state is efficient and mimics the social planner's outcome, taxes should be held constant in response to government expenditure shocks. This condition holds in a standard Mortensen-Pissarides model that includes a dividend- and a labor-income tax. When the model is augmented to include endogenous search intensity, or a labor force participation choice, the addition of value-added taxes ensures both efficiency as well as complete tax smoothing. Tax volatility, however, remains optimal whenever the economies are exposed to supply side disturbances.