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The winners and losers of tax reform: An assessment under financial integration

Ayşe Kabukçuoğlu

Journal of Economic Dynamics and Control, 2017, vol. 85, issue C, 90-122

Abstract: I quantify the macroeconomic and redistributive effects of the unilateral elimination of the capital income tax in a two-country, heterogeneous-agent incomplete markets model with progressive labor income taxes. Home, by implementing the reform, induces government responses where labor income is taxed in Home and mostly subsidized in Foreign. In addition, post-reform price dynamics reduce Home’s wealth and suppress households’ ability to do consumption smoothing, with negative effects on the majority—particularly on the poor. In turn, Foreign accumulates wealth, and price movements work particularly in favor of the poor. As a result, a large majority in Home prefers the status quo whereas Foreign supports the reform unanimously. These findings are robust to alternative scenarios where (i) the borrowing constraints are relaxed, (ii) both countries jointly eliminate capital income taxes, (iii) foreign interest income is taxed, and (iv) Home capital income tax is reduced from 40% to 35%.

Keywords: Taxation; Wealth inequality; Heterogeneous agent-incomplete markets models; Financial integration (search for similar items in EconPapers)
JEL-codes: E62 F41 D52 F68 (search for similar items in EconPapers)
Date: 2017
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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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