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Optimal income taxes and tariffs in a small economy

Author

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  • Dinopoulos, Elias
  • Unel, Bulent

Abstract

We introduce a stylized model of an economy with occupational choice, income taxes, and tariffs. The government maximizes a utilitarian welfare function subject to a revenue requirement. In the small open economy (SOE) case, the government implements a free-trade policy, and either imposes a flat tax or a progressive tax on high-income entrepreneurs. In a closed-economy scenario, the government imposes a regressive tax on low-income workers while exempting (or subsidizing) high-income entrepreneurs. A transition from a closed economy to an SOE improves optimal income tax progressivity.

Suggested Citation

  • Dinopoulos, Elias & Unel, Bulent, 2026. "Optimal income taxes and tariffs in a small economy," European Economic Review, Elsevier, vol. 187(C).
    • Handle: RePEc:eee:eecrev:v:187:y:2026:i:c:s0014292126001261
    DOI: 10.1016/j.euroecorev.2026.105382
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    Keywords

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    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship

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