Current Account Deficits and the Welfare of Future Generations

This paper explores the effects of one nation's taxation of consumption on the welfare of future generations of other countries. To do this, it presents an otherwise standard one-good, two-country optimal growth model with free capital markets, but where each date represents the lifetime of a generation which cares not only about its own consumption and leisure, but also that of its descendants. Relative to a no tax benchmark, a policy of one country taxing consumption of its initial generations has ambiguous welfare effects for future generations of the other country, as long as those future generations are not too far in the future. Higher initial savings in the first country raises capital levels, and thus wages, in both countries, raising welfare of future generations in the second country, but also induces lower bequests in the second country, lowering the welfare of its future generations. In the long run, or for generations born near the steady state, the welfare effects of the first country inducing lower consumption of its initial generations are unambiguous: future generations of the second country are made worse off. Households born in the second country will regret that their ancestors allowed such policy-induced intertemporal trade.