Tax cuts in open economies

Alejandro Cunat, Szabolcs Deák, Marco Maffezzoli

Publications: Contribution to journalArticlePeer Reviewed

Abstract

A reduction in capital tax rates generates substantial dynamic responses within the framework of the standard neoclassical growth model. The short-run revenue loss after a 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 that international 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 revenues in steady state.

Original languageEnglish
Pages (from-to)83-108
Number of pages26
JournalReview of Economic Dynamics
Volume45
Early online date27 May 2021
DOIs
Publication statusPublished - Jul 2022

Austrian Fields of Science 2012

  • 502003 Foreign trade
  • 502018 Macroeconomics

Keywords

  • CMI
  • Cat2
  • International trade
  • Heckscher-Ohlin
  • Taxation
  • Revenue estimation
  • Dynamic macroeconomics
  • Laffer curve

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