Supply-Side Economics in a Global Economy
Abstract
Recent quantitative studies predict large welfare gains from reducing tax distortions in a closed economy, despite costly transitional dynamics to more efficient tax systems. This paper examines transitional dynamics and gains of tax reforms for countries in a global economy, and provides numerical solutions for international tax competition games. Tax reforms in a global economy cause cross-country externalities through capital flows in response to consumption-smoothing and debt-servicing effects, with taxes on world payments affecting the distribution of welfare gains. Within the class of time-invariant tax rates, the gains of replacing income taxes with consumption taxes are large and, in the absence of taxes on foreign assets, the monopoly distortion separating cooperative and noncooperative equilibria is negligible. The analysis starts from a benchmark reflecting current G-7 fiscal policies, and considers the effects of tax reforms on real exchange rates and interest differentials. Tax-distorted equilibrium dynamics are computed using a modified version of the King-Plosser-Rebelo algorithm augmented with shooting routines.
ABSTRACT Recent quantitative studies predict large welfare gains from reducing tax distortions in a closed economy, despite costly transitional dynamics to more efficient tax systems. This paper examines transitional dynamics and gains oftax reforms for countries in a global economy, and provides numerical solutions for international tax competition games. Tax reforms in a global economy cause cross-country externalities through capital flows in response to consumption-smoothingand debt-servicingeffects, with taxeson world paymentsaffectingthedistribution ofwelfaregains. Within the classoftime-invarianttax rates, the gainsof replacing incometaxeswith consumptiontaxes are large and, in the absence oftaxes on foreign assets, the monopoly distortion separatingcooperative and noncooperative equilibriais negligible. Theanalysisstartsfrom abenchmarkreflecting currentG-7 fiscal policies, and considers the effectsoftax reformsonreal exchange rates and interestdifferentials. Tax-distortedequilibrium dynamics are computed using a modified version ofthe King-Plosser-Rebelo algorithm augmented with shooting routines.
Cite this document
Enrique G. Mendoza and Linda L. Tesar (1995). Supply-Side Economics in a Global Economy (IFDP 1995-507). Board of Governors of the Federal Reserve System, International Finance Discussion Papers. https://whenthefedspeaks.com/doc/ifdp_1995-507
@techreport{wtfs_ifdp_1995_507,
author = {Enrique G. Mendoza and Linda L. Tesar},
title = {Supply-Side Economics in a Global Economy},
type = {International Finance Discussion Papers},
number = {1995-507},
institution = {Board of Governors of the Federal Reserve System},
year = {1995},
url = {https://whenthefedspeaks.com/doc/ifdp_1995-507},
abstract = {Recent quantitative studies predict large welfare gains from reducing tax distortions in a closed economy, despite costly transitional dynamics to more efficient tax systems. This paper examines transitional dynamics and gains of tax reforms for countries in a global economy, and provides numerical solutions for international tax competition games. Tax reforms in a global economy cause cross-country externalities through capital flows in response to consumption-smoothing and debt-servicing effects, with taxes on world payments affecting the distribution of welfare gains. Within the class of time-invariant tax rates, the gains of replacing income taxes with consumption taxes are large and, in the absence of taxes on foreign assets, the monopoly distortion separating cooperative and noncooperative equilibria is negligible. The analysis starts from a benchmark reflecting current G-7 fiscal policies, and considers the effects of tax reforms on real exchange rates and interest differentials. Tax-distorted equilibrium dynamics are computed using a modified version of the King-Plosser-Rebelo algorithm augmented with shooting routines.},
}