Working Paper

The redistributional consequences of tax reform under financial integration

Abstract: I quantify the welfare effects of replacing the US capital income tax with higher labor income taxes under international financial integration using a two-country, heterogeneous-agent incomplete markets model calibrated to represent the US and the rest of the world. Short-run and long-run factor price dynamics are key: after the tax reform, interest rates rise less under financial openness than in autarky. Therefore, wealthy households gain less. Post-tax wages also fall less as a result of the faster capital accumulation, so the poor are hurt less. Hence, the distributional impacts of the reform are significantly dampened relative to autarky although a majority of households prefer the status quo. Aggregate welfare effect to the US is a permanent 0.2% consumption equivalent loss under financial openness which is roughly 15% of the welfare loss under autarky.

Keywords: tax reform; welfare;

JEL Classification: D52; E62; F41; F68;

https://doi.org/10.24149/gwp188

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2014-08-01

Number: 188