Saving Europe?

Jing Zhang

No 599, 2015 Meeting Papers from Society for Economic Dynamics

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.

Date: 2015
New Economics Papers: this item is included in nep-dge and nep-pbe
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