Optimal Taxation Policies in the EMS: A Two-Country Model of Public Finance

Constraints on policy variables that are likely to develop in the context of the European Monetary System by 1992 are incorporated into a public finance framework. The effects of such constraints on the optimal use of the inflation and consumption tax are analyzed. Two questions are addressed: how the constraint of a common inflation rate, necessary to preserve fixed exchange rates, influences optimal policy decisions concerning the inflation tax; and how the harmonization of consumption taxes affects the spread between national inflation rates.