Tax Reforms, "Free Lunches", and "Cheap Lunches" in Open Economies

Download or read book Tax Reforms, "Free Lunches", and "Cheap Lunches" in Open Economies written by Giovanni Ganelli and published by International Monetary Fund. This book was released on 2008-09 with total page 32 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper focuses on the macroeconomic and budgetary impact of tax reforms in a New Keynesian two-country model. Our results show that both income and consumption unilateral tax rate reductions do not constitute a "free lunch", in the sense that they have negative budgetary consequences for the country which implements them. In addition, the degree of self-financing implied by our model is in the 81⁄2-24 percent range. Since the degree of self-financing estimated in previous literature was larger, we conclude that in our model not only the "lunch" is not "free", but is also not that "cheap". A comparison of alternative (income-tax versus consumption-tax based) fiscal stimulus packages shows that consumption tax cuts imply a larger short-run impact on domestic output but the income tax cuts stimulate the domestic economy more in the long run. We also look at the implications of a revenue-neutral tax reform in which consumption taxes are increased to compensate for lower income tax collection.