Public goods, tax policies, and unemployment in LDCs

Abstract

We build a general equilibrium model of a small open economy characterized by unemployment and producing two privately traded goods and one nontraded public consumption good. The provision of public good is financed with an income tax or an excise tax on the manufactured good or an import tariff. Within this framework, the paper examines the effects of such policies on the country's unemployment ratio and welfare, and it derives the efficiency rules for public good provision for each policy instrument. It shows, among other things, that the private marginal cost of the public good always overstates its social marginal cost in the case of income taxes and may overstate it in the case of an excise tax on the manufactured good or a tariff even if the taxed good and the public good are substitutes in consumption.