Supply-Side Economics in an Integrated World Economy

IMF Working Papers, November 1, 1993

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Supply-Side Economics in an Integrated World Economy

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Bibliographic details

• Authors: Linda L. Tesa, Enrique G. Mendoza
• Published: November 1, 1993
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451955095.001

Overview

• Examines macroeconomic effects of changes in tax and expenditure policies within the competitive equilibrium of a two-country, two-sector model of an integrated world economy.
• Governments finance purchases and net transfers of tradable and nontradable goods by imposing distortionary taxes on factor incomes and consumption.
• The model is parameterized and calibrated using data from large industrial economies, including estimates of effective tax rates.
• Numerical simulations estimate welfare costs associated with existing distortionary taxes and potential gains from more efficient use of these taxes.

Methodology and calibration

• Framework: competitive equilibrium, two-country, two-sector integrated world economy model.
• Fiscal instruments modeled: distortionary taxes on factor incomes and consumption; government purchases and net transfers of tradable and nontradable goods.
• Calibration: uses data from large industrial economies and includes estimates of effective tax rates.
• Analysis tool: numerical simulations to quantify welfare costs and gains.

Key findings

• Welfare gains from tax reforms favoring indirect taxation are substantial.
• The effects of permanent changes in expenditures depend on:
  • Their sectoral allocation across tradables and nontradables.
  • Whether they are debtor tax-financed.
• Trade in goods and assets is very sensitive to fiscal policy changes.
• Aggregate consumption patterns and welfare implications are not very sensitive to fiscal policy changes.

Policy implications and recommendations

• Shifting tax structures toward more efficient use of taxation—particularly favoring indirect taxation—can yield substantial welfare gains.
• Fiscal policy design must consider sectoral allocation of expenditures (tradables vs nontradables) and financing modality (including debtor tax-financing) because these determine macroeconomic effects.
• Policymakers should account for high sensitivity of trade in goods and assets to fiscal changes even when aggregate consumption and welfare effects appear muted.

Linda L. Tesa and Enrique G. Mendoza, "Supply-Side Economics in an Integrated World Economy", IMF Working Papers 1993, 081 (1993), November 1, 1993.