Abstract : We introduce imperfect labor markets into the tax competition framework. Countries set tax rates on profit and income. Labor is immobile across countries, while capital is mobile. We show the importance of asymmetries in labor market institutions for the optimal tax policy. While most of the labor market variables play no role for the tax rates in autarchic countries, they become important when tax competition is introduced. Especially, we find that a country with “better” labor market institutions taxes capital at a higher rate and income at a lower rate compared to a country with “bad” labor markets.