Working Paper: CEPR ID: DP6347
Authors: Harry Huizinga; Eric Schaling; Peter C. van der Windt
Abstract: Both in theory and practice, capital controls and dual exchange rate systems can be part of a country's optimal tax policy. We first show how a dual exchange rate system can be interpreted as a tax (or subsidy) on international capital income. We show that a dual exchange rate system, with separate commercial and financial exchange rates, drives a wedge between the domestic and foreign returns on comparable assets. As a borrower, the government itself is a direct beneficiary. Secondly, based on data from South Africa, we present empirical evidence of this revenue implicit in a dual exchange rate system; a revenue that amounted to as much as 0.1 percent of GDP for the South African government. However, this paper also shows that both the capital controls and the dual exchange rate system in South Africa gave rise to many perverse unanticipated effects. The latter may render capital controls and dual exchange rate systems unattractive in the end and, thereby, provides a rationale for the recent trend in exchange rate liberalization and unification.
Keywords: capital controls; dual exchange rate systems; financial repression
JEL Codes: H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dual exchange rate system (F31) | Tax on foreign source income (F38) |
| Dual exchange rate system (F31) | Lower domestic interest rate (E43) |
| Lower domestic interest rate (E43) | Subsidy for foreign investors (F23) |
| Dual exchange rate system (F31) | Implicit subsidy (H23) |
| Implicit subsidy (H23) | Affects domestic interest rates (E43) |
| Dual exchange rate system (F31) | Impact on government's fiscal position (E62) |
| Dual exchange rate system (F31) | Attractiveness of capital controls (F38) |