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Deficits with Distortionary Taxes: International Dimensions

  • Jacob A. Frenkel
  • Assaf Razin

This paper deals with the international effects of budget deficits arising from distortionary tax and transfer policies. The analysis demonstrates that the consequences of tax policies and the characteristics of the international transmission mechanism depend critically on the precise composition of taxes. Specifically, the international effects of budget deficits of a given size differ sharply according to the types of taxes used to generate the deficit. We show that in determining the effects of taxes it is useful to divide the various distortionary taxes into two groups: those that stimulate current external borrowing (national dissaving) and those that stimulate current external lending (national saving). A pro-borrowing tax policy raises the world rate of interest while a pro-lending tax policy lowers it. The resulting change in the rate of interest is the channel through which the effects of budget deficits are transmitted to the rest of the world. The key propositions are illustrated by a series of examples involving consumption taxes (VAT), taxes on income of labor and capital and taxes on international borrowing.

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File URL: http://www.nber.org/papers/w2080.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2080.

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Date of creation: Nov 1986
Date of revision:
Publication status: published as IMF Staff Papers. vol.25,no.1 pp57-87, March 1988
Handle: RePEc:nbr:nberwo:2080
Note: EFG ITI IFM
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  1. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  2. Torsten Persson, 1983. "Deficits and Intergenerational Welfare in Open Economies," NBER Working Papers 1083, National Bureau of Economic Research, Inc.
  3. Jeremy Greenwood & Kent P. Kimbrough, 1985. "Capital Controls and Fiscal Policy in the World Economy," Canadian Journal of Economics, Canadian Economics Association, vol. 18(4), pages 743-65, November.
  4. Feldstein, Martin S, 1974. "Incidence of a Capital Income Tax in a Growing Economy with Variable Savings Rates," Review of Economic Studies, Wiley Blackwell, vol. 41(4), pages 505-13, October.
  5. Frenkel, Jacob A & Razin, Assaf, 1986. "Fiscal Policies in the World Economy," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 564-94, June.
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