Saving Europe? : the unpleasant arithmetic of fiscal austerity in integrated economies

  • 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.

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Author:Enrique G. Mendoza, Linda L. Tesar, Jing Zhang
Parent Title (German):SAFE working paper series ; No. 80
Series (Serial Number):SAFE working paper (80)
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2014
Year of first Publication:2014
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2014/12/17
Tag:European debt crisis; capacity utilization; fiscal austerity; tax competition
Issue:December 12, 2014
Page Number:61
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / House of Finance (HoF)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht