Tax Cuts in Open EconomiesBy Alejandro Cuńat, Szabolcs Deák and Marco Maffezzoli
A reduction in income tax rates generates substantial dynamic responses within the frame-work of the standard neoclassical growth model. The short-run revenue loss after an in-come tax cut is partly -- or, depending on parameter values, even completely -- offsetby 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 weallow a Ramsey economy to engage in international trade: the open economy's ability toreallocate resources between labor-intensive and capital-intensive industries reduces thenegative effect of factor accumulation on factor returns, thus encouraging the economy toaccumulate more than it would do under autarky. We explore the quantitative implica-tions 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 tradeenhances the response of government revenue to tax cuts by a relevant amount. In ourbenchmark calibration, a reduction in the capital-income tax rate has virtually no effecton government revenue in steady state.
JEL Classification: E13, E60, F11, F43, H20
Keywords: international trade, Heckscher-Ohlin, dynamic macroeconomics, taxation, revenue estimation, Laffer Curve
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