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Welfare Effects of Tax Policy in Open Economies: Stabilization and Cooperation

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  • Henry Kim
  • Jinill Kim

Abstract

This paper studies optimal tax policy design problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfare-improving active, contingent tax policies (tax rates respond to changes in productivity) on consumption, and capital and labor income taxes. Unlike the conventional wisdom regarding stabilization policies, procyclical factor income tax policy is optimal in open economy. Procyclical tax policy generates efficiency gains by correcting market incompleteness. Optimal tax policy under cooperative equilibrium is similar to that under the Nash equilibrium and welfare gains from tax policy coordination is quite small.

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Bibliographic Info

Paper provided by Department of Economics, Tufts University in its series Discussion Papers Series, Department of Economics, Tufts University with number 0503.

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Date of creation: 2005
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Handle: RePEc:tuf:tuftec:0503

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Keywords: optimal tax; procyclical; countercyclical; stabilization; cooperation.;

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