Tax Reforms, “Free Lunches”, and “Cheap Lunches” in Open Economies

September 1, 2008

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Juha Tervala, and Giovanni Ganelli. Tax Reforms, “Free Lunches”, and “Cheap Lunches” in Open Economies, (USA: International Monetary Fund, 2008) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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 8½-24 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.

Subject: Consumption, Consumption taxes, Income and capital gains taxes, Revenue administration, Tax collection

Keywords: Expenditure switching, Income tax, Money demand, Tax rate, WP

Publication Details

Pages:

30
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2008/227
Stock No:

WPIEA2008227
ISBN:

9781451870855
ISSN:

1018-5941

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