We re-examine the optimality of tax smoothing from the point of view of frictional labor markets. Our central result is that whether or not this cornerstone optimal fiscal policy prescription carries over to an environment with labor market frictions depends crucially on the cyclical nature of...

quasi-rent view. In the long run, however, the quasi-rent equilibrium is welfare-superior.

versions of our environment, capital-income subsidies are consistent with zero intertemporal distortions. Our main conclusion is that capital-tax policy can fundamentally be driven by monetary issues.