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Deficits with Distortionary Taxes: International Dimensions

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  • Jacob A. Frenkel
  • Assaf Razin

Abstract

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.

Suggested Citation

  • Jacob A. Frenkel & Assaf Razin, 1986. "Deficits with Distortionary Taxes: International Dimensions," NBER Working Papers 2080, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2080
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    1. van Wijnbergen, Sweder, 1985. "Taxation of International Capital Flows, the Intertemporal Terms of Trade and the Real Price of Oil," Oxford Economic Papers, Oxford University Press, vol. 37(3), pages 382-390, September.
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    4. Frenkel, Jacob A & Razin, Assaf, 1986. "Fiscal Policies in the World Economy," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 564-594, June.
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    1. Leiderman, Leonardo & Razin, Assaf, 1988. "Testing Ricardian Neutrality with an Intertemporal Stochastic Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(1), pages 1-21, February.
    2. Obstfeld, Maurice, 1989. "Fiscal deficits and relative prices in a growing world economy," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 461-484, May.

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