Tax Reforms, “Free Lunches”, and “Cheap Lunches” in Open Economies
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Summary:
This paper focuses on the macroeconomic and budgetary impact of tax reforms in a New Keynesian two-country model. Our results show that both income and consumption unilateral tax rate reductions do not constitute a "free lunch", in the sense that they have negative budgetary consequences for the country which implements them. In addition, the degree of self-financing implied by our model is in the 8½-24 percent range. Since the degree of self-financing estimated in previous literature was larger, we conclude that in our model not only the "lunch" is not "free", but is also not that "cheap". A comparison of alternative (income-tax versus consumption-tax based) fiscal stimulus packages shows that consumption tax cuts imply a larger short-run impact on domestic output but the income tax cuts stimulate the domestic economy more in the long run. We also look at the implications of a revenue-neutral tax reform in which consumption taxes are increased to compensate for lower income tax collection.
Series:
Working Paper No. 2008/227
Subject:
Consumption Consumption taxes Income and capital gains taxes Revenue administration Tax collection
Frequency:
Quarterly
English
Publication Date:
September 1, 2008
ISBN/ISSN:
9781451870855/1018-5941
Stock No:
WPIEA2008227
Pages:
30
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