Optimal tourism taxation with labor market distortions

This paper investigates optimal tourism taxation in the presence of labor market distortions. Constructing a general equilibrium model where the government imposes a labor income tax and a tourism tax to finance a fixed amount of public spending, we examine the welfare effect of a revenue-neutral increase in tourism tax starting from the first-best level with no labor market distortions. We show that if the foreign tourist’s demand is highly elastic, then the tourism tax reform exacerbates labor market distortions, and hence decreases overall welfare. We also show that if the reform starts from the situation in which no tourism tax is imposed initially, then it has no harmful spillover effect on the labor market, and hence improves welfare.