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The International Ramifications of Tax Reforms: Supply-Side Economics in a Global Economy

Enrique G. Mendoza¹; Linda L. Tesar

¹ Duke University

This paper studies tax reforms in a dynamic model of a global economy calibrated to current U.S. and European tax policies. World capital markets add consumption-smoothing and income-redistribution effects that alter closed-economy predictions. In the absence of taxes on foreign interest, welfare gains of eliminating U.S. income taxes are enlarged by up to 34 percent at the expense of European losses caused by transitional declines in consumption and leisure and a permanent capital outflow. In contrast, if foreign interest is taxed, the same tax reform reduces U.S. welfare 0.7 percent and increases European welfare 1.8 percent. Copyright 1998 by American Economic Association.

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