The Winners and Losers of Tax Reform: An Assessment under Financial Integration
Posted: 8 Jul 2016
Date Written: August 7, 2014
I quantify the macroeconomic and redistributive effects of replacing the US capital income tax with higher labor income taxes under international financial integration using a two-country, heterogeneous-agent incomplete markets model calibrated to represent the US and the rest of the world. Short-run and long-run factor price dynamics are key: after the tax reform, interest rates rise less under financial openness than in autarky. Therefore, wealthy households gain less. Post-tax wages also fall less as a result of the faster capital accumulation, so the poor are hurt less. Hence, the distributional impacts of the reform are significantly dampened relative to autarky although a majority of households prefer the status quo. Aggregate welfare effect to the US is a permanent 0.2% consumption equivalent loss under financial openness which is roughly 15% of the welfare loss under autarky.
Keywords: Taxation, Redistribution, Financial Integration, Heterogeneous agent-incomplete market models
JEL Classification: E62, F41, D52, F68
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