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Tax Cuts in Open Economies

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  • Alejandro Cuñat
  • Szabolcs Deák
  • Marco Maffezzoli

Abstract

A reduction in capital tax rates generates substantial dynamic responses within the framework of the standard neoclassical growth model. The short-run revenue loss after a tax cut is partly — or, depending on parameter values, even completely — offset by growth in the long-run, due to the resulting incentives to further accumulate capital. We study how the dynamic response of government revenue to a tax cut changes if we allow a Ramsey economy to engage in international trade: the open economy's ability to reallocate resources between labor-intensive and capital-intensive industries reduces the negative effect of factor accumulation on factor returns, thus encouraging the economy to accumulate more than it would do under autarky. We explore the quantitative implications of this intuition for the US in terms of two issues recently treated in the literature: dynamic scoring and the Laffer curve. Our results demonstrate that international trade enhances the response of government revenue to tax cuts by a relevant amount. In our benchmark calibration, a reduction in the capital-income tax rate has virtually no effect on government revenues in steady state.

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Bibliographic Info

Paper provided by DEGIT, Dynamics, Economic Growth, and International Trade in its series DEGIT Conference Papers with number c015_052.

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Length: 31 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:deg:conpap:c015_052

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Keywords: International Trade; Heckscher-Ohlin; Dynamic Macroeconomics; Taxation; Revenue Estimation; Laffer Curve;

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  1. Marco Maffezzoli, 2004. "Convergence Across Italian Regions and the Role of Technological Catch-Up," Working Papers 274, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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  7. Paul Gomme & Peter Rupert, 2004. "Measuring labor’s share of income," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Nov.
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  17. Novales, Alfonso & Ruiz, Jesus, 2002. "Dynamic Laffer curves," Journal of Economic Dynamics and Control, Elsevier, vol. 27(2), pages 181-206, December.
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  19. Bruce, Neil & Turnovsky, Stephen J, 1999. "Budget Balance, Welfare, and the Growth Rate: "Dynamic Scoring" of the Long-Run Government Budget," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(2), pages 162-86, May.
  20. Shoven, John B & Whalley, John, 1984. "Applied General-Equilibrium Models of Taxation and International Trade: An Introduction and Survey," Journal of Economic Literature, American Economic Association, vol. 22(3), pages 1007-51, September.
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