Saving Europe? The unpleasant arithmetic of fiscal austerity in integrated economies

Enrique Mendoza, Linda L. Tesar and Jing Zhang

No 80, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: Europe's 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 either Nash competition or Cooperation reduces (increases) capital (labor) taxes significantly, and leaves countries with larger debt shocks preferring autarky.

Keywords: European debt crisis; capacity utilization; fiscal austerity; tax competition (search for similar items in EconPapers)
JEL-codes: E61 E62 E66 F34 F42 F62 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-dge, nep-eec and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (43)

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Related works:
Working Paper: Saving Europe?: The Unpleasant Arithmetic of Fiscal Austerity in Integrated Economies (2014)
Working Paper: Saving Europe?: The Unpleasant Arithmetic of Fiscal Austerity in Integrated Economies (2014)
Working Paper: Saving Europe?: The Unpleasant Arithmetic of Fiscal Austerity in Integrated Economies (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:80

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