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### Modeling approach and tax definitions
- The introduction of the CIT into GIMF allows the model to more closely resemble the corporate income tax base in many countries, so that the tax is levied on the economic profits (income) made by corporates.
- Definitions:
  - A CFT taxes the cash flows of corporates from sales after deducting the cost of labor, investment, and intermediate inputs.
  - Under a DBCFT, revenues from exports are not subject to tax, while the cost of imports cannot be deducted, reflecting the destination-based component of the tax.
- Related literature mentioned:
  - Robinson and Thierfelder (2017) consider the introduction of the DBCFT but focus on trade and prices rather than GDP.
  - Keuschnigg (1991) uses a stylized overlapping-generations, two-country, one-good open-economy model to show positive long-run effects on capital, GDP, investment and wage growth regardless of openness.
  - Barbiero and others (2018) obtain similar results on border adjustment in a two-country DSGE model.
  - Bond and Devereux (see Devereux and de la Feria, 2014) and Auerbach and others (2017) advocate destination-basis CFTs and discuss benefits and implementation.

### Macroeconomic effects: transitional and long-run
- Tax-shifting decomposed into two components:
  - Shift from a CIT to a CFT:
    - Induces the corporate sector to invest more.
    - Boosts potential output, GDP and consumption in the long run.
    - Crowds out consumption in the short run as households save to build up capital stock.
    - Under a CFT, investment expenditures are fully deducted immediately; the tax falls exclusively on rents, creating incentives to invest.
    - Shifting from an income base to a cash-flow base removes tax incentives to leverage, so firms facing financial frictions borrow less.
  - Shift from origin-based to destination-based:
    - Taxable base changes from including domestic and foreign revenues to only domestic revenues; deduction for imported intermediate goods is eliminated.
    - Leads to an appreciation of the currency to offset the competitiveness boost and maintain domestic investment-saving equilibrium.
- Short-run under sticky-price assumptions:
  - Exchange rate appreciation pass-through to import prices is delayed because importing firms are slow to reduce prices.
  - Results in a fall in imports in the near term driven by initial consumption decline and delayed pass-through.
  - For the rest of the world, exports to the reforming country decline due to lower import demand despite the appreciation.

### Interactions with financial frictions and global spillovers
- Financial frictions modify effects of reform:
  - Interest expense deductibility under a CIT partly offsets distortions from a CIT, reducing the long-run boost to investment and GDP from cutting the CIT.
  - Implementation of the CFT reduces the cost of capital immediately via investment expenditure deductibility, which lowers the value of assets on firms’ balance sheets; with unchanged debt, firms’ leverage rises and banks tighten lending in the short run.
- When the reforming economy is large:
  - Additional spillovers to the rest of the world via global investment, saving and the real interest rate.
  - Long run: increased savings in the reforming country lower the global real interest rate, boosting investment, consumption and GDP in all countries.
  - Transition: higher domestic investment demand can put mild upward pressure on global real interest rates, dampening domestic demand in non-reforming countries; total short-run impact on GDP in non-reforming countries is negative but small.
  - Global GDP increases notably when all countries undertake the reform.

### Advantages of CFT/DBCFT
- Historical proponents: Brown (1948), the Meade Committee (1978), King (1987) argued CFTs can be less distortionary.
- Key arguments and advantages:
  - CFT falls exclusively on rents and does not alter the economy’s desired level of capital, unlike taxes on returns to capital.
  - Equal treatment of debt and equity capital under a CFT since CIT can allow for interest deductibility.
  - Destination-basis CFTs create few distortions and can be similar to VAT in an open-economy setting without affecting labor supply (as argued by Bond and Devereux and others).

### Caveats, limitations, and implementation challenges
- Modeling limitations (driven by GIMF structure and simplification for computation) omit potentially important channels:
  - Multinational firms could modify transfer prices, relocate patents, change financial structures, or relocate production to jurisdictions with less distortionary tax systems—leading to profit and/or production shifting; these channels are absent because the framework does not incorporate multinational firms.
  - Simplifying assumptions related to currency denomination of foreign liabilities prevent the model from capturing balance sheet effects of exchange rate movements.
- Legal and political challenges to DBCFT implementation:
  - Principal obstacle: potential incompatibility with WTO rules.
  - Proponents have suggested implementing as a combination of a VAT plus a payroll subsidy, since both are compliant with WTO rules (Auerbach and others, 2017).
  - Additional challenges around tax collection and practical implementation are discussed in Devereux and de la Feria (2014) and Auerbach and others (2017).
- Modeling caveat references:
  - Sandmo (1971) shows CFTs are non-distortionary only if they are not changed in the future.
  - Auerbach and others (2017) and Box 1 of the April 2017 Fiscal Monitor discuss advantages of destination-based cash flow taxes.

### Literature review: CIT reforms in general equilibrium models
- General finding: Reducing or abolishing corporate income taxes (CITs) in U.S. and European-focused general equilibrium models usually yields significantly positive output effects, though magnitudes vary with the size of the tax cut and how it is financed.
- Representative quantitative results from the literature:
  - Carroll and others (2006): U.S. long-run output can increase by up to 6 percent under a progressive consumption tax plan.
  - Diamond and Zodrow (2006): U.S. long-run output can increase by up to 5 percent under a flat tax.
  - Fehr and others (2013): U.S. output increases by a little over 4 per cent in the long run when eliminating CIT and substituting consumption and labor taxes.
  - Benzell and others (2017) and Bhattarai and others (2017): significant medium-run output effects in multi-region and closed-economy models respectively.
  - Radulescu and Stimmelmayr (2010): the 2008 German tax reform (CIT rate lowered by 10pp) produced negative effects on the corporate sector of around 2pp.
  - Keuschnigg and Dietz: output increase of around a half a percent from dividend and capital gains tax changes.
- On ACE and CBIT:
  - ACE (allowance for corporate equity) typically boosts output by adding a deductibility for returns to equity.
  - CBIT (comprehensive business income tax) abolishes interest deductibility of corporate debt and tends to lower output.
  - The net impact of ACE and CBIT depends on how resulting revenue shortfalls or gains are financed.

### Intuition for desirability of (destination-based) cash-flow taxes
- Capital market distortions:
  - In absence of taxes and financial frictions standard relation: R_K = r + δ. (2)
  - With τ_CIT = 0, the relative change in the long-run rental rate of capital implies the return to capital is increasing with the CIT; a higher CIT requires a higher pre-tax return and therefore lower capital and output.
  - With τ_CFT = 0, the tax rate does not affect the required return to capital, hence investment is unaffected by a CFT in the absence of financial frictions.
  - With financial frictions: ∂fp/∂τ_CIT < 0. (5) The presence of a CIT reduces the external finance premium (fp) because corporates receive tax credits when losses occur, making borrowers less risky.
- Labor market distortions:
  - Labor market equilibrium (GIMF): L = L̄[1 − φ(1 + τ_C) (1 − τ_L) (R_K)^α/(1−α) C]. (6)
  - Corporate taxes affect labor indirectly through R_K: an increase in R_K (from a distortionary tax like a CIT) lowers hours worked and hence output.
  - In GIMF the substitution effect tends to dominate, leading to a decline in labor when R_K rises.
- Export and import price distortions:
  - Steady-state import and export prices under a destination-based component (DBCFT):
    - P_M = (1 − τ_CFT) (1 − τ_CFT)^(−Ω_DBCFT τ_DBCFT_CFT) ε P* . (7)
    - P_X = (1 − τ_CFT)^(−Ω_DBCFT τ_DBCFT_CFT) (1 − τ_CFT) P_Y . (8)
    - Ω_DBCFT = 0 for an origin-based CFT, = 1 for DBCFT.
  - With CIT set to zero, a DBCFT acts as an export subsidy (lowers export prices) and an import tariff (increases import prices); restoring external equilibrium requires real exchange adjustment equal to the tax change.
  - Summary: CFTs do not distort equilibrium conditions; the DBCFT affects the exchange rate only. CITs are distortionary (raise R_K, lower capital stock and output) and do not impact import/export prices.

### Tax reform scenarios (setup and common assumptions)
- Common assumptions across scenarios:
  - Fiscal authorities implement fiscal changes fully in the first year.
  - No administrative or information costs.
  - Agents understand the change and believe it is permanent.
  - In the first year the fiscal changes are revenue neutral.
  - Agents know non-distortionary transfer payments are used to stabilize debt in the long run.
  - Monetary policy in all regions can respond; nominal exchange rates are fully flexible.
  - Results shown for Country A (large open economy) and the rest of the world (aggregates B and C).

- Scenario 1 — Replacing a CIT by a CFT (No financial frictions)
  - Experiment: Country A replaces all CIT revenue by a cash flow tax (CFT); model version without financial frictions.
  - Key outcomes:
    - The CFT itself is non-distortive: the marginal impact of introducing the CFT is zero when other corporate taxes are set to zero.
    - Abolition of the CIT is expansionary in the long run: firms raise desired capital and investment, increasing the capital stock.
    - Short run: investment and capital stock increase only gradually due to costly adjustment; consumption falls near term as households save to finance additional investment.
    - External and saving dynamics:
      - Domestic private savings initially insufficient to fund near-term investment increase → current account deteriorates.
      - Eventually private savings increase more than investment → households acquire foreign assets; net foreign assets (NFA) as a share of GDP are higher in the new steady state.
      - Global real interest rates rise in the near term to induce needed global savings; later they fall in response to additional private savings in Country A.
    - Long-run magnitude:
      - GDP expands by roughly 4 percent above the initial baseline in response to raising 2.7 percent of GDP in fiscal revenue via a CFT rather than via a CIT.
    - Spillovers:
      - Near term: rest-of-world exports increase, current account improves, but domestic demand declines due to higher global real interest rates, dampening output.
      - Further out: consumption and investment in rest of world are boosted by lower global real interest rates and terms-of-trade improvement as imports from Country A become cheaper.

- Scenario 2 — Replacing a CIT by a DBCFT (No financial frictions)
  - Experiment: Replace CIT by a destination-based cash flow tax (DBCFT); model version without financial frictions.
  - Reform components: (i) remove CIT, (ii) introduce CFT, (iii) introduce border adjustment shifting taxable base to domestic revenues only and eliminating deduction for cost of imported intermediate goods.
  - Key outcomes:
    - Long run: CFT and DBCFT yield identical macro variables except for the real exchange rate, which appreciates under DBCFT.
    - Short run: price stickiness and passthrough produce significant differences:
      - Exporting firms receive a tax benefit (foreign sales not taxed) → long-run lower export prices but sticky in short run.
      - Importing firms lose deduction on imported inputs → import prices increase immediately.
      - Immediate effects: imports fall more under DBCFT than under pure CFT; net exports provide additional near-term demand support → amplifies output increase on impact.
      - Current account initially deteriorates under DBCFT because after-tax export prices fall while after-tax import prices increase; as prices adjust, current account improves driven by higher private savings.
    - Spillovers:
      - Short run: decline in Country A imports causes sizeable reduction in exports and output in rest of world relative to CFT case.
      - Long run: similar to CFT case—consumption and investment in rest of world are boosted by lower global real interest rates and terms-of-trade improvement owing to decline in price of imports from Country A.

- Scenario 3: All Countries Replacing a CIT by a DBCFT (No Financial Frictions)
  - When all countries undertake the reform simultaneously, firms in all countries raise their investment due to the abolition of the CIT and introduction of the DBCFT.
  - Near-term dynamics:
    - Excess demand for investment relative to savings is larger, resulting in higher global real interest rates.
    - Higher global real interest rates crowd out consumption in all countries and dampen investment in country A relative to the unilateral case.
    - The introduction of the border adjustment and reduction in global consumption result in a decline in country A’s exports; GDP declines in the near term in country A.
    - Country A’s real exchange rate does not appreciate because the destination-based component affects all countries symmetrically.
  - Long-run dynamics:
    - Net foreign asset positions and current accounts are unchanged.
    - The impact on domestic variables in the long run is greater for country A relative to the unilateral-reform case.
    - Higher consumption and investment by the rest of the world drives stronger export demand for country A.
    - Country A benefits from even lower global real interest rates in the long run, which boost private consumption.

- Scenario 4: Replacing a CIT by a DBCFT (With Financial Frictions)
  - Model features:
    - Firms can finance some of the capital stock with debt; interest expenses are deductible under a CIT.
    - Interest expense deductibility represents an implicit debt subsidy that lowers after-tax costs and increases optimal leverage.
  - Key mechanisms and effects:
    - Abolition of the CIT removes a smaller distortion under debt financing, so the increase in firms’ desired capital stock is smaller than in the no-debt case.
    - Abolishing the CIT reduces firms’ leverage; introduction of a DBCFT lowers the value of existing capital relative to future capital, lowering Tobin’s Q and firm value, further reducing corporate debt.
    - Presence of debt financing and financial frictions reduces the positive long-run GDP impact of replacing the CIT with a DBCFT.
    - Moving from a CIT to DBCFT yields a much smaller increase in firms’ desired stock of capital under financial frictions.
  - Transition path and short-run effects:
    - A permanent increase in the DBCFT reduces firm value via lower after-tax dividend streams; investment adjustment costs lead to Q overshooting in the near term, sharply reducing capital stock value, causing leverage to spike and the external finance premium to rise.
    - Consequently, investment falls sharply in the short run and consumption falls.
    - The initial drop in investment reduces labor demand and real wages, lowering consumption.
    - Monetary policy eases in response to weaker domestic demand, producing a smaller near-term currency appreciation relative to the no-financial-frictions case; this supports exports and dampens imports, but overall GDP declines in the near term.
  - Net foreign asset (NFA) and current account implications:
    - Decline in firm value and corporate debt reduces domestic private debt; OLG households demand more foreign assets to maintain desired financial wealth.
    - The current account quickly moves into surplus; country A’s net foreign asset position converges to a much higher level relative to the no-debt-financing case.

### Conclusions (Section V)
- Replacing a corporate income tax by cash flow taxes:
  - Boosts output in the reforming country and produces positive long-run spillovers to the rest of the world.
  - Transmission mechanism: removal of a distortion on the required return to capital, boosting investment, potential output, and consumption.
  - Rest of the world benefits through additional demand for imports by the reforming country, improved terms of trade, and lower global interest rates in response to increased savings in the reforming country.
- Dependence on type of cash flow tax and financial frictions:
  - When the cash flow tax includes a border adjustment and import and export prices are sticky, the reforming country receives an additional near-term output boost driven by stronger exports and weaker imports; this boost disappears once prices fully adjust.
  - In the presence of financial frictions, benefits are significantly reduced because interest expense deductibility makes the CIT less distortionary.
  - Interaction with financial frictions increases the external finance premium in the short run, mitigating benefits on the return to capital and leading to a near-term decline in output for the reforming country.
- Multilateral adoption:
  - When all countries undertake the same reform, the benefits from the tax reform are larger.

### Appendix: Summary of the Global Integrated Monetary and Fiscal Model (GIMF) and key calibration
- Model structure and features:
  - GIMF is a multicountry DSGE model with optimizing households and firms and full intertemporal stock-flow accounting.
  - Frictions: sticky prices and wages, real adjustment costs, liquidity-constrained households, finite-planning horizons for households—providing roles for monetary and fiscal policy in stabilization.
  - Finite horizons yield well-defined steady states where countries can be long-run debtors or creditors and allow analysis of transitions between steady states.
  - Non-Ricardian features generate non-neutrality in spending-based and revenue-based fiscal measures.
  - Asset markets are incomplete: government debt held domestically as nominal one-period domestic-currency bonds; internationally tradable assets are nominal one-period U.S. dollar bonds.
  - Firms are domestically owned; equity is not traded domestically—households receive lump-sum dividends.
  - Financial accelerator: cost of external finance rises with firms’ indebtedness; banks provide fixed-term deposits and loans; lending rate includes an external financing premium tied to leverage.
  - GIMF is multi-region with explicit bilateral trade flows, relative prices, and exchange rates. The version used has 3 regions with identical structural parameters but different relative sizes.
- Household sector:
  - Two household types: OLG (overlapping-generation) and LIQ (liquidity-constrained).
  - OLG households optimize over a 20-year planning horizon.
  - LIQ households do not save and have marginal propensity to consume equal to unity.
  - For OLG households, tax cuts matched by future tax increases that stabilize debt can still produce a short-run positive effect on output because future liabilities fall beyond their planning horizon.
- Production sector:
  - Firms produce tradable and nontradable intermediate goods, have finite horizons, face nominal rigidities, and real adjustment costs; retained earnings insufficient to fully finance investment, so firms borrow.
  - Firms operate in monopolistic competition; exports priced to destination markets; imports face quantity adjustment costs.
  - Public infrastructure (government capital stock) is an input to production.
- International dimensions and spillovers:
  - All bilateral trade flows and relative prices are modeled; international linkages driven by global saving and investment decisions from consumers’ finite horizons.
  - Net foreign asset positions are represented by U.S.-dollar-denominated nominal one-period bonds.
- Fiscal and monetary policy:
  - Fiscal policy instruments include consumption or investment government spending, lump-sum transfers (general or targeted to LIQ households), labor and capital income taxes, consumption taxes, corporate income taxes, and cash flow taxes with a destination-based component (DBCFT).
  - Under DBCFT: revenues from exports are not taxed; costs of imports are not deductible.
  - Fiscal rule ensures long-run sustainability (debt-to-GDP ratio converges to target) while allowing short-run countercyclical policies.
  - Monetary policy follows an inflation-forecast-based interest rate rule.

- Calibration details (model version used in paper) — selected entries reproduced exactly:
  - Three regions: Country A ≈ 25 percent of world economy; Country B ≈ 5 percent; Country C (rest of world) ≈ 70 percent.
  - Steady-state world technology growth rate: 1.5 percent per annum
  - World population growth rate: 1 percent per annum
  - Steady-state inflation rates for all regions: 2 percent
  - Long-run real interest rate: 3 percent per annum
  - Discount factor for households: 0.99
  - OLG average remaining time at work: 20 years (probability of survival 0.95)
  - Productivity decline of households as they age: 0.95
  - Intertemporal elasticity of substitution: 0.5
  - Elasticity of labor supply reported in text: 0.5
  - Habit formation parameter: 0.4
  - Production-side parameters reported in text: depreciation rate 10 percent; labor share 65 percent; share of tradeable goods in production 40 percent
- Table A: Key Parameters of the GIMF calibration (selected entries reproduced exactly)
  - Annual growth 1.5 percent
  - Population growth 1 percent
  - Global real interest rate 3 percent
  - Inflation Target 2 percent
  - Discount Factor 0.99
  - Int. elast. of substitution 0.5
  - Prob. of Survival 0.95
  - Labor supply Elasticity 0.7
  - Prod. decline 0.95
  - Habit formation 0.4
  - Depreciation Rate 10 percent
  - Labor Share (percent of GDP) 65
  - Tradeable Share (percent total output) 40
  - Expenditure Shares (percent of GDP): Consumption 58; Investment 20; Government Spending 22.5; Exports (Imports) 21
  - Other shares (percent of GDP unless stated): Tax Revenue 30; Corporate Tax Revenue 2.7; Consumption Tax Revenue 6.5; Labor Income Tax Revenue 13; Wage Income 65; Capital Income 32; Government Debt 85; NFA 0

*Source: wp1913 - introduction of the CIT into GIMF, allows the model to more closely resemble the corporate income tax base in*

### introduction of the CIT  into GIMF,  allows the model to more closely resemble the corporate income tax base in

### introduction of the CIT  into GIMF,  allows the model to more closely resemble the corporate income tax base in

### Modeling approach and tax definitions
- The introduction of the CIT into GIMF allows the model to more closely resemble the corporate income tax base in many countries, so that the tax is levied on the economic profits (income) made by corporates.
- Definitions:
  - A CFT taxes the cash flows of corporates from sales after deducting the cost of labor, investment, and intermediate inputs.
  - Under a DBCFT, revenues from exports are not subject to tax, while the cost of imports cannot be deducted, reflecting the destination-based component of the tax.
- Related literature mentioned:
  - Robinson and Thierfelder (2017) consider the introduction of the DBCFT but focus on trade and prices rather than GDP.
  - Keuschnigg (1991) uses a stylized overlapping-generations, two-country, one-good open-economy model to show positive long-run effects on capital, GDP, investment and wage growth regardless of openness.
  - Barbiero and others (2018) obtain similar results on border adjustment in a two-country DSGE model.
  - Bond and Devereux (see Devereux and de la Feria, 2014) and Auerbach and others (2017) advocate destination-basis CFTs and discuss benefits and implementation.

### Macroeconomic effects: transitional and long-run
- Tax-shifting decomposed into two components:
  - Shift from a CIT to a CFT:
    - Induces the corporate sector to invest more.
    - Boosts potential output, GDP and consumption in the long run.
    - Crowds out consumption in the short run as households save to build up capital stock.
    - Under a CFT, investment expenditures are fully deducted immediately; the tax falls exclusively on rents, creating incentives to invest.
    - Shifting from an income base to a cash-flow base removes tax incentives to leverage, so firms facing financial frictions borrow less.
  - Shift from origin-based to destination-based:
    - Taxable base changes from including domestic and foreign revenues to only domestic revenues; deduction for imported intermediate goods is eliminated.
    - Leads to an appreciation of the currency to offset the competitiveness boost and maintain domestic investment-saving equilibrium.
- Short-run under sticky-price assumptions:
  - Exchange rate appreciation pass-through to import prices is delayed because importing firms are slow to reduce prices.
  - Results in a fall in imports in the near term driven by initial consumption decline and delayed pass-through.
  - For the rest of the world, exports to the reforming country decline due to lower import demand despite the appreciation.

### Interactions with financial frictions and global spillovers
- Financial frictions modify effects of reform:
  - Interest expense deductibility under a CIT partly offsets distortions from a CIT, reducing the long-run boost to investment and GDP from cutting the CIT.
  - Implementation of the CFT reduces the cost of capital immediately via investment expenditure deductibility, which lowers the value of assets on firms’ balance sheets; with unchanged debt, firms’ leverage rises and banks tighten lending in the short run.
- When the reforming economy is large:
  - Additional spillovers to the rest of the world via global investment, saving and the real interest rate.
  - Long run: increased savings in the reforming country lower the global real interest rate, boosting investment, consumption and GDP in all countries.
  - Transition: higher domestic investment demand can put mild upward pressure on global real interest rates, dampening domestic demand in non-reforming countries; total short-run impact on GDP in non-reforming countries is negative but small.
  - Global GDP increases notably when all countries undertake the reform.

### Advantages of CFT/DBCFT
- Historical proponents: Brown (1948), the Meade Committee (1978), King (1987) argued CFTs can be less distortionary.
- Key arguments and advantages:
  - CFT falls exclusively on rents and does not alter the economy’s desired level of capital, unlike taxes on returns to capital.
  - Equal treatment of debt and equity capital under a CFT since CIT can allow for interest deductibility.
  - Destination-basis CFTs create few distortions and can be similar to VAT in an open-economy setting without affecting labor supply (as argued by Bond and Devereux and others).

### Caveats, limitations, and implementation challenges
- Modeling limitations (driven by GIMF structure and simplification for computation) omit potentially important channels:
  - Multinational firms could modify transfer prices, relocate patents, change financial structures, or relocate production to jurisdictions with less distortionary tax systems—leading to profit and/or production shifting; these channels are absent because the framework does not incorporate multinational firms.
  - Simplifying assumptions related to currency denomination of foreign liabilities prevent the model from capturing balance sheet effects of exchange rate movements.
- Legal and political challenges to DBCFT implementation:
  - Principal obstacle: potential incompatibility with WTO rules.
  - Proponents have suggested implementing as a combination of a VAT plus a payroll subsidy, since both are compliant with WTO rules (Auerbach and others, 2017).
  - Additional challenges around tax collection and practical implementation are discussed in Devereux and de la Feria (2014) and Auerbach and others (2017).
- Modeling caveat references:
  - Sandmo (1971) shows CFTs are non-distortionary only if they are not changed in the future.
  - Auerbach and others (2017) and Box 1 of the April 2017 Fiscal Monitor discuss advantages of destination-based cash flow taxes.

### Organization of the paper
- Section II: selected summary of key papers examining CIT reform.
- Section III: intuition for why replacing a CIT by a CFT or DBCFT boosts capital, potential output and GDP.
- Section IV: tax reform experiments.

*Source: wp1913 - introduction of the CIT  into GIMF,  allows the model to more closely resemble the corporate income tax base in*

### Section V concludes.

### Section V concludes.

### II. CIT reforms in general equilibrium models: literature review
- General finding: Reducing or abolishing corporate income taxes (CITs) in U.S. and European-focused general equilibrium models usually yields significantly positive output effects, though magnitudes vary with the size of the tax cut and how it is financed.
- Representative quantitative results from the literature:
  - Carroll and others (2006): U.S. long-run output can increase by up to 6 percent under a progressive consumption tax plan.
  - Diamond and Zodrow (2006): U.S. long-run output can increase by up to 5 percent under a flat tax.
  - Fehr and others (2013): U.S. output increases by a little over 4 per cent in the long run when eliminating CIT and substituting consumption and labor taxes.
  - Benzell and others (2017) and Bhattarai and others (2017): significant medium-run output effects in multi-region and closed-economy models respectively.
  - Radulescu and Stimmelmayr (2010): the 2008 German tax reform (CIT rate lowered by 10pp) produced negative effects on the corporate sector of around 2pp.
  - Keuschnigg and Dietz: output increase of around a half a percent from dividend and capital gains tax changes.
- On ACE and CBIT:
  - ACE (allowance for corporate equity) typically boosts output by adding a deductibility for returns to equity.
  - CBIT (comprehensive business income tax) abolishes interest deductibility of corporate debt and tends to lower output.
  - The net impact of ACE and CBIT depends on how resulting revenue shortfalls or gains are financed.

### III. On the desirability of (destination-based) cash-flow taxes: intuition
- Purpose: Explain why cash-flow taxes (CFTs) are less distortive than CITs via three key market distortions: capital accumulation, labor market, and trade (import/export prices). Focus is on steady state.

- A. Capital market distortions
  - Return to capital in the steady state (with 100 percent depreciation allowance) is given by equation (1) in the source (notation preserved).
  - In absence of taxes and financial frictions standard relation:
    - R_K = r + δ.          (2)
  - Abstracting from financial frictions (fp = 1) and assuming only one corporate tax at a time:
    - With τ_CIT = 0, the relative change in the long-run rental rate of capital satisfies equation (3a), implying the return to capital is increasing with the CIT; a higher CIT requires a higher pre-tax return and therefore lower capital and output.
    - With τ_CFT = 0, equation (4) shows the tax rate does not affect the required return to capital, hence investment is unaffected by a CFT in the absence of financial frictions.
  - With financial frictions:
    - ∂fp/∂τ_CIT < 0.          (5)
    - The presence of a CIT reduces the external finance premium (fp) because corporates receive tax credits when losses occur, making borrowers less risky.
    - The impact of a tax increase on R_K in the presence of financial frictions is given by equation (3b), which—given (5) and initial fp>1—implies a smaller long-run distortion from CIT than without financial frictions.

- B. Labor market distortions
  - Labor market equilibrium (GIMF) is:
    - L = L̄[1 − φ(1 + τ_C) (1 − τ_L) (R_K)^α/(1−α) C],         (6)
    - where variables and parameters retain the source definitions.
  - Corporate taxes affect labor indirectly through R_K: an increase in R_K (from a distortionary tax like a CIT) lowers hours worked and hence output.
  - Overall labor response depends on wealth vs substitution effects; in GIMF the substitution effect tends to dominate, leading to a decline in labor.

- C. Export and import price distortions
  - Steady-state import and export prices under a destination-based component (DBCFT) are:
    - P_M = (1 − τ_CFT) (1 − τ_CFT)^(−Ω_DBCFT τ_DBCFT_CFT) ε P* ,        (7)
    - P_X = (1 − τ_CFT)^(−Ω_DBCFT τ_DBCFT_CFT) (1 − τ_CFT) P_Y ,        (8)
    - where notation (P_M, P_X, P*, P_Y, ε, Ω_DBCFT) is preserved from the source and Ω_DBCFT = 0 for an origin-based CFT, = 1 for DBCFT.
  - With CIT set to zero, a DBCFT acts as an export subsidy (lowers export prices) and an import tariff (increases import prices); restoring external equilibrium requires real exchange adjustment equal to the tax change.
  - Summary: CFTs do not distort equilibrium conditions; the DBCFT affects the exchange rate only. CITs are distortionary (raise R_K, lower capital stock and output) and do not impact import/export prices.

### IV. Tax reform scenarios (setup and common assumptions)
- Four scenarios considered (calibration referenced as in Appendix, not reproduced here). Scenario 4 examines financial frictions.
- Common assumptions across scenarios:
  - Fiscal authorities implement fiscal changes fully in the first year.
  - No administrative or information costs.
  - Agents understand the change and believe it is permanent.
  - In the first year the fiscal changes are revenue neutral.
  - Agents know non-distortionary transfer payments are used to stabilize debt in the long run.
  - Monetary policy in all regions can respond; nominal exchange rates are fully flexible.
  - Results shown for Country A (large open economy) and the rest of the world (aggregates B and C).

- A. Scenario 1 — Replacing a CIT by a CFT (No financial frictions)
  - Experiment: Country A replaces all CIT revenue by a cash flow tax (CFT); model version without financial frictions.
  - Key simulation observations:
    - The CFT itself is non-distortive: the marginal impact of introducing the CFT is zero when other corporate taxes are set to zero (blue and red lines/bars equal in figures).
    - The abolition of the CIT is expansionary in the long run: firms raise desired capital and investment, increasing the capital stock.
    - Short run: investment and capital stock increase only gradually due to costly adjustment; consumption falls near term as households save to finance additional investment.
    - External and saving dynamics:
      - Domestic private savings initially insufficient to fund near-term investment increase → current account deteriorates.
      - Eventually private savings increase more than investment → households acquire foreign assets; net foreign assets (NFA) as a share of GDP are higher in the new steady state.
      - Global real interest rates rise in the near term to induce needed global savings; later they fall in response to additional private savings in Country A.
    - Long-run magnitudes (preserved exactly):
      - GDP expands by roughly 4 percent above the initial baseline in response to raising 2.7 percent of GDP in fiscal revenue via a CFT rather than via a CIT.
    - The CFT introduction by itself has no impact on economic variables absent other corporate taxes (equations (1) and (4)); differences in taxable dividends are rebated via lump-sum transfers.
    - Spillovers to the rest of the world:
      - Near term: rest-of-world exports increase, current account improves, but domestic demand declines due to higher global real interest rates, dampening output.
      - Further out: consumption and investment in rest of world are boosted by lower global real interest rates and terms-of-trade improvement as imports from Country A become cheaper.

- B. Scenario 2 — Replacing a CIT by a DBCFT (No financial frictions)
  - Experiment: Replace CIT by a destination-based cash flow tax (DBCFT); model version without financial frictions.
  - Reform components: (i) remove CIT, (ii) introduce CFT, (iii) introduce border adjustment shifting taxable base to domestic revenues only and eliminating deduction for cost of imported intermediate goods.
  - Key simulation observations:
    - Long run: CFT and DBCFT yield identical macro variables except for the real exchange rate, which appreciates under DBCFT.
    - Short run: significant differences due to price stickiness and passthrough:
      - Exporting firms receive a tax benefit (foreign sales not taxed) under DBCFT → long-run lower export prices but sticky in short run.
      - Importing firms lose deduction on imported inputs → import prices increase immediately when entering the DBCFT country.
      - DBCFT reproduces price implications of a depreciation but necessitates a compensatory real appreciation to maintain current-account balance.
      - Immediate effects: imports fall more under DBCFT than under pure CFT; net exports provide additional near-term demand support → amplifies output increase on impact.
      - Current account initially deteriorates under DBCFT because after-tax export prices fall while after-tax import prices increase; as prices adjust, current account improves driven by higher private savings.
    - Spillovers to rest of world:
      - Short run: decline in Country A imports causes sizeable reduction in exports and output in rest of world relative to CFT case.
      - Long run: similar to CFT case—consumption and investment in rest of world are boosted by lower global real interest rates and terms-of-trade improvement owing to decline in price of imports from Country A.

*Source: wp1913 - Section V concludes.*

### introduction  of the  destination-based component.

### introduction  of the  destination-based component.

### Scenario 3: All Countries Replacing a CIT by a DBCFT (No Financial Frictions)
- When all countries undertake the reform simultaneously, firms in all countries raise their investment due to the abolition of the CIT and introduction of the DBCFT.
- Near-term dynamics when all countries reform:
  - Excess demand for investment relative to savings is larger, resulting in higher global real interest rates.
  - Higher global real interest rates crowd out consumption in all countries and dampen investment in country A relative to the unilateral case.
  - The introduction of the border adjustment and reduction in global consumption result in a decline in country A’s exports; GDP declines in the near term in country A.
  - Country A’s real exchange rate does not appreciate because the destination-based component affects all countries symmetrically.
- Long-run dynamics when all export and import prices adjust:
  - Net foreign asset positions and current accounts are unchanged.
  - The impact on domestic variables (consumption, investment, exports, imports and GDP) in the long run is greater for country A relative to the unilateral-reform case.
  - On the export side, higher consumption and investment by the rest of the world (RoW) drives stronger export demand for country A.
  - Country A benefits from even lower global real interest rates in the long run, which boost private consumption.

### Scenario 4: Replacing a CIT by a DBCFT (With Financial Frictions)
- Model features:
  - Firms can finance some of the capital stock with debt; interest expenses are deductible under a CIT.
  - Interest expense deductibility represents an implicit debt subsidy that lowers after-tax costs and increases optimal leverage.
- Key mechanisms and effects:
  - Abolition of the CIT removes a smaller distortion under debt financing, so the increase in firms’ desired capital stock is smaller than in the no-debt case.
  - Abolishing the CIT reduces firms’ leverage; introduction of a DBCFT lowers the value of existing capital relative to future capital, lowering Tobin’s Q and firm value, further reducing corporate debt.
  - Presence of debt financing and financial frictions reduces the positive long-run GDP impact of replacing the CIT with a DBCFT.
  - Interest expense deductibility reduces the burden of the CIT on firms’ required return to capital; CIT also provides a tax credit when losses are incurred, reducing firm riskiness and the external finance premium.
  - Moving from a CIT to DBCFT yields a much smaller increase in firms’ desired stock of capital under financial frictions.
- Transition path and short-run effects:
  - A permanent increase in the DBCFT reduces firm value via lower after-tax dividend streams; investment adjustment costs lead to Q overshooting in the near term, sharply reducing capital stock value, causing leverage to spike and the external finance premium to rise.
  - Consequently, investment falls sharply in the short run and consumption falls.
  - The initial drop in investment reduces labor demand and real wages, lowering consumption.
  - Monetary policy eases in response to weaker domestic demand, producing a smaller near-term currency appreciation relative to the no-financial-frictions case; this supports exports and dampens imports, but overall GDP declines in the near term.
- Net foreign asset (NFA) and current account implications:
  - Decline in firm value and corporate debt reduces domestic private debt; OLG households demand more foreign assets to maintain desired financial wealth.
  - The current account quickly moves into surplus; country A’s net foreign asset position converges to a much higher level relative to the no-debt-financing case.

### Conclusions (V. CONCLUSIONS)
- Replacing a corporate income tax by cash flow taxes:
  - Boosts output in the reforming country and produces positive long-run spillovers to the rest of the world.
  - Transmission mechanism: removal of a distortion on the required return to capital, boosting investment, potential output, and consumption.
  - Rest of the world benefits through additional demand for imports by the reforming country, improved terms of trade, and lower global interest rates in response to increased savings in the reforming country.
- Dependence on type of cash flow tax and financial frictions:
  - When the cash flow tax includes a border adjustment and import and export prices are sticky, the reforming country receives an additional near-term output boost driven by stronger exports and weaker imports; this boost disappears once prices fully adjust.
  - In the presence of financial frictions, benefits are significantly reduced because interest expense deductibility makes the CIT less distortionary.
  - Interaction with financial frictions increases the external finance premium in the short run, mitigating benefits on the return to capital and leading to a near-term decline in output for the reforming country.
- Multilateral adoption:
  - When all countries undertake the same reform, the benefits from the tax reform are larger.

### Appendix: Summary of the Global Integrated Monetary and Fiscal Model (GIMF)
- Model structure and features:
  - GIMF is a multicountry DSGE model with optimizing households and firms and full intertemporal stock-flow accounting.
  - Frictions: sticky prices and wages, real adjustment costs, liquidity-constrained households, finite-planning horizons for households—providing roles for monetary and fiscal policy in stabilization.
  - Finite horizons yield well-defined steady states where countries can be long-run debtors or creditors and allow analysis of transitions between steady states.
  - Non-Ricardian features generate non-neutrality in spending-based and revenue-based fiscal measures.
  - Asset markets are incomplete: government debt held domestically as nominal one-period domestic-currency bonds; internationally tradable assets are nominal one-period U.S. dollar bonds.
  - Firms are domestically owned; equity is not traded domestically—households receive lump-sum dividends.
  - Financial accelerator: cost of external finance rises with firms’ indebtedness; limited menu of financial assets; banks provide fixed-term deposits and loans; lending rate includes an external financing premium tied to leverage.
  - GIMF is multi-region with explicit bilateral trade flows, relative prices, and exchange rates. The version used has 3 regions with identical structural parameters but different relative sizes.
- Household sector:
  - Two household types: OLG (overlapping-generation) and LIQ (liquidity-constrained).
  - OLG households optimize over a 20-year planning horizon.
  - LIQ households do not save and have marginal propensity to consume equal to unity.
  - For OLG households, tax cuts matched by future tax increases that stabilize debt can still produce a short-run positive effect on output because future liabilities fall beyond their planning horizon.
- Production sector:
  - Firms produce tradable and nontradable intermediate goods, have finite horizons, face nominal rigidities, and real adjustment costs; retained earnings insufficient to fully finance investment, so firms borrow.
  - Firms operate in monopolistic competition; exports priced to destination markets; imports face quantity adjustment costs.
  - Public infrastructure (government capital stock) is an input to production.
- International dimensions and spillovers:
  - All bilateral trade flows and relative prices are modeled; international linkages driven by global saving and investment decisions from consumers’ finite horizons.
  - Net foreign asset positions are represented by U.S.-dollar-denominated nominal one-period bonds.
- Fiscal and monetary policy:
  - Fiscal policy instruments include consumption or investment government spending, lump-sum transfers (general or targeted to LIQ households), labor and capital income taxes, consumption taxes, corporate income taxes, and cash flow taxes with a destination-based component (DBCFT).
  - Under DBCFT: revenues from exports are not taxed; costs of imports are not deductible.
  - Fiscal rule ensures long-run sustainability (debt-to-GDP ratio converges to target) while allowing short-run countercyclical policies.
  - Monetary policy follows an inflation-forecast-based interest rate rule.
- Calibration details (model version used in paper):
  - Three regions: Country A ≈ 25 percent of world economy; Country B ≈ 5 percent; Country C (rest of world) ≈ 70 percent.
  - Steady-state parameters and key calibrations:
    - Steady-state world technology growth rate: 1.5 percent per annum
    - World population growth rate: 1 percent per annum
    - Steady-state inflation rates for all regions: 2 percent
    - Long-run real interest rate: 3 percent per annum
    - Discount factor for households: 0.99
    - OLG average remaining time at work: 20 years (probability of survival 0.95)
    - Productivity decline of households as they age: 0.95
    - Intertemporal elasticity of substitution: 0.5
    - Elasticity of labor supply reported in text: 0.5
    - Habit formation parameter: 0.4
    - Production-side parameters reported in text: depreciation rate 10 percent; labor share 65 percent; share of tradeable goods in production 40 percent
  - Note: the table of key parameters reports Labor supply Elasticity 0.7 (the text also reports elasticity of labor supply as 0.5; both appear in the source).
- Table A: Key Parameters of the GIMF calibration (selected entries reproduced exactly)
  - Annual growth 1.5 percent
  - Population growth 1 percent
  - Global real interest rate 3 percent
  - Inflation Target 2 percent
  - Discount Factor 0.99
  - Int. elast. of substitution 0.5
  - Prob. of Survival 0.95
  - Labor supply Elasticity 0.7
  - Prod. decline 0.95
  - Habit formation 0.4
  - Depreciation Rate 10 percent
  - Labor Share (percent of GDP) 65
  - Tradeable Share (percent total output) 40
  - Expenditure Shares (percent of GDP): Consumption 58; Investment 20; Government Spending 22.5; Exports (Imports) 21
  - Other shares (percent of GDP unless stated): Tax Revenue 30; Corporate Tax Revenue 2.7; Consumption Tax Revenue 6.5; Labor Income Tax Revenue 13; Wage Income 65; Capital Income 32; Government Debt 85; NFA 0

*Source: wp1913 - introduction  of the  destination-based component.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2019/wp1913.pdf_