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Saving Europe?

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  • Jing Zhang

    (Federal Reserve Bank of Chicago)

Abstract

Europes debt crisis casts doubt on the effectiveness of fiscal austerity in highly-integrated economies. Closed-economy models overestimate its effectiveness, because they underestimate tax-base elasticities and ignore cross-country tax externalities. In contrast, we study tax responses to debt shocks in a two-country model with endogenous utilization that captures those externalities and matches the capital-tax-base elasticity. Quantitative results show that unilateral capital tax hikes cannot restore fiscal solvency in Europe, and have large negative (positive) effects at "home" ("abroad"). Restoring solvency via Nash competition reduces capital taxes sharply but increases labor taxes, and even the Cooperative equilibrium lowers (rises) capital (labor) taxes.

Suggested Citation

  • Jing Zhang, 2015. "Saving Europe?," 2015 Meeting Papers 599, Society for Economic Dynamics.
    • Handle: RePEc:red:sed015:599
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    References listed on IDEAS

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