On the Welfare Gains From International Fiscal Coordination

The paper sets up an overlapping model of two economies linked by capital mobility to study the potential welfare gains from international coordination of tax and expenditure policies. The first part of the paper deals with the long run and finds that if the marginal source of public finance is a capital income tax based on the source principle, countries can almost certainly gain by undertaking a coordinated increase in their level of taxation and public expenditure. By contrast, if expenditure is instead financed by a capital income tax or by a comprehensive income tax based on the residence principle, it is likely that countries can gain by undertaking a coordinated reduction of their public budgets, The long run analysis also identifies some special cases in which there is no welfare gain from international policy coordination. The second part of the paper sets up a dynamic version of the model and shows that the coordinated policies which will benefit present generations may be quite different from those which will benefit future generations. The analysis thus highlights the potential intergenerational conflicts involved in the formulation of optimal coordination policies.