Unemployment,Government Spending and the Laffer Effect*

The paper studies the effects of income tax rate changes in a general equilibrium model with frictional unemployment. Laffer curve effects, by which a tax rate reduction may increase the level of government spending or its share in output, are shown to be possible under certain conditions. These are the presence of unemployment benefit payments, government budget balance through fiscal spending adjustment and limited quantitative importance of labour reallocation costs. Endogenous government spending acts as a fiscal accelerator if the fiscal burden of unemployment benefit payments is large, but reduces the employment effects of tax rate cuts if it is low.