Welfare Effects of Tax Policy in Open Economies: Stabilization and Cooperation
32 Pages Posted: 20 Dec 2003
Date Written: October 2003
This paper studies an international tax policy design problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfareimproving active tax policies, in particular capital and labor income tax, under the non-cooperative Nash equilibrium and the cooperative equilibrium. Unlike the conventional wisdom regarding stabilization policies, optimal tax policies in our economy are procyclical. Relative to the non-cooperative setting, international tax policy cooperation requires more active tax policies (about two times) and generates large extra welfare gains (by about a third).
Keywords: Income tax, welfare, stabilization, cooperation
JEL Classification: F4, E6
Suggested Citation: Suggested Citation