Tax incidence in an open economy with unemployment of labor

It is shown that Harberger's (1962) tax incidence result is robust in the sense that introduction of money, unemployment, and trade into his analysis does not alter its qualitative nature. A tax incidence model is developed of a small open economy with unemployment of labor by following the Das (1982) tariff model with modifications. Das' fixed coefficient technology assumption is replaced by continuous factor substitutability in production. The only tax in the system is on the use of capital in the nontraded good (NTG) sector. If the NTG sector is capital (labor) intensive, there will be an excess supply (demand) of (for) capital that will reduce (raise) the rental relative to the given wage rate. With a capital-intensive NTG sector, the total effect of the tax will be negative, so that tax will reduce the relative income of capital. If the sector is labor intensive, the total effect becomes ambiguous. Thus, Harberger's basic result holds so long as capital is perfectly mobile and fully utilized.