Working Paper: CEPR ID: DP4164
Authors: Willem H. Buiter; Anne Sibert
Abstract: In a dynamic optimizing model with costly tax collection, a tax cut by one nation creates positive externalities for the rest of the world if initial public debt stocks are positive. By reducing tax collection costs, current tax cuts boost the resources available for current private consumption, lowering the global interest rate. This pecuniary externality benefits other countries because it reduces the tax collection costs for foreign governments of current and future debt service. In the non-cooperative equilibrium, nationalistic governments do not allow for the effect of lower domestic taxes on debt service costs abroad. Taxes are too high and government budget deficits too low compared to the global cooperative equilibrium. Even in the cooperative equilibrium complete tax smoothing is not optimal: current taxes will be lower than future taxes.
Keywords: Fiscal Policy; International Policy Coordination; Optimal Taxation
JEL Codes: E62; F42; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax Cut (H29) | Decrease in Tax Collection Costs (H26) |
| Decrease in Tax Collection Costs (H26) | Increase in Resources Available for Private Consumption (E21) |
| Increase in Resources Available for Private Consumption (E21) | Lower Global Interest Rate (E43) |
| Tax Cut (H29) | Lower Global Interest Rate (E43) |
| Lowering Taxes Initially (H29) | Positive Welfare Spillover Effect (D69) |
| Positive Welfare Spillover Effect (D69) | Decrease in Debt Service Costs for All Countries (F34) |