Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/106145
Authors: 
Mendoza, Enrique G.
Tesar, Linda L.
Zhang, Jing
Year of Publication: 
2014
Series/Report no.: 
SAFE Working Paper Series 80
Abstract: 
Europe's debt crisis casts doubt on the effectiveness of fiscal austerity in highly-integrated economies. Closed-economy models overestimate its effectiveness, because they underestimate tax-base elasticities and ignore cross-country tax externalities. In contrast, we study tax responses to debt shocks in a two-country model with endogenous utilization that captures those externalities and matches the capital-tax-base elasticity. Quantitative results show that unilateral capital tax hikes cannot restore fiscal solvency in Europe, and have large negative (positive) effects at "home" ("abroad"). Restoring solvency via either Nash competition or Cooperation reduces (increases) capital (labor) taxes significantly, and leaves countries with larger debt shocks preferring autarky.
Subjects: 
European debt crisis
capacity utilization
fiscal austerity
tax competition
JEL: 
E61
E62
E66
F34
F42
F62
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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