Tax cuts in open economies

Cunat, Alejandro, Deak, Szabolcs and Maffezzoli, Marco (2008) Tax cuts in open economies. CEPDP (860). London School of Economics and Political Science. Centre for Economic Performance, London, UK. ISBN 9780853282563

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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.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://cep.lse.ac.uk
Additional Information:	© 2008 the authors
Divisions:	Centre for Economic Performance
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HJ Public Finance
JEL classification:	E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E13 - Neoclassical E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy Formation, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E60 - General F - International Economics > F1 - Trade > F11 - Neoclassical Models of Trade H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H20 - General F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F43 - Economic Growth of Open Economies
Date Deposited:	18 Jul 2008 08:42
Last Modified:	11 Dec 2024 18:52
URI:	http://eprints.lse.ac.uk/id/eprint/19620

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