Abstract
The effects of a tax cut in an open economy with a sticky real wage are studied. In the short run the lower the tax rate, the lower the real wage. The long-run movement of this wage rate depends on the level of output. In the short run, a tax cut will increase output, but the effects on the trade balance, price level and total tax revenue are ambiguous. A reduced relative price between domestic and imported goods is a necessary condition for an improved trade balance, which in turn is a necessary condition for an increase in tax revenue. In the long run, the tax cut will have no output effect, while the real wage and the relative price between domestic and imported goods will rise and the trade balance will deteriorate. The price level will increase if the exchange rate is fixed, but is unaffected if the exchange rate is flexible.
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