Tax Cuts in Open Economies

Alejandro Cunat, Szabolcs Deak and Marco Maffezzoli (marco.maffezzoli@unibocconi.it)

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: A reduction in income tax rates generates substantial dynamic responses within the framework of the standard neoclassical growth model. The short-run revenue loss after an income tax cut is partly - or, depending on parameter values, even completely - offset by growth in the long-run, due to the resulting incentives to further accumulate capital. We study how the dynamic response of government revenue to a tax cut changes if we allow a Ramsey economy to engage in international trade: the open economy's ability to reallocate resources between labor-intensive and capital-intensive industries reduces the negative effect of factor accumulation on factor returns, thus encouraging the economy to accumulate more than it would do under autarky. We explore the quantitative implications of this intuition for the US in terms of two issues recently treated in the literature: dynamic scoring and the Laffer curve. Our results demonstrate the internaional trade enhances the response of government revenue to tax cuts by a relevant amount. In our benchmark calibration, a reduction in the capital-income tax rate has virtually no effect on government revenue in steady state.

Keywords: international trade; Heckscher-Ohlin; dynamic macroeconomics; taxation; revenue estimation; Laffer curve (search for similar items in EconPapers)
JEL-codes: E13 E60 F11 F43 H20 (search for similar items in EconPapers)
Date: 2008-03
New Economics Papers: this item is included in nep-acc, nep-dge, nep-int, nep-mac, nep-opm and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Tax Cuts in Open Economies (2022)
Working Paper: Tax Cuts in Open Economies (2010)
Working Paper: Tax cuts in open economies (2008)
Working Paper: Tax Cuts in Open Economies (2008)
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