We investigate the dynamic and steady-state effects of a change in consumption and labor tax rates (“social VAT”) in a two-sector small open economy with capital accumulation and endogenous employment. With fixed labor, the substitution of payroll tax on wage for consumption tax leaving unchanged the government budget constraint induces solely a rise in wage rate together with a fall in the marginal utility of wealth, leaving unchanged steady-state levels of variables. Instead, by extending the two-sector model by Turnovsky and Sen (1995) to elastic labor, we find that the fiscal policy crowds-in consumption and investment expenditure both in the short-run and the long-run and raises employment. The analytical tractability of the model allows us to characterize the transitional paths and the factors governing the impact and long-term effects. Interestingly, while steady-state changes remain almost qualitatively independent of sectoral capital intensities, sectoral capital-labor ratios matter in determining the size of long-run variations. Numerical exercises show that: [i] beneficial effects on labor-market can be large (depending on initial tax wedge, sectoral capital-labor ratios and elasticity of labor supply), and [ii] balanced-budget fiscal multipliers derived from the change in tax structure fall in the range 0.2-0.4 approximately as the elasticity of labor supply falls in the range between 0.5-1.