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country. In any case, we believe our initial income tax rates to be within the ballpark of the range of plausible estimates for many industrial and emerging market economies.

B a x t e r a n d K i n g ( 1 9 9 3 ) a n d I r e l a n d ( 1 9 9 4 ) , f o r e x a m p l e , u s e 2 . 0 0 = I τ a s a b e n c h m a r k i n p a r a m e t e r i z a t i o n s o f t h e U S e c o n o m y , w h i l e M a n k i w a n d W e i n z i e r l ( 2 0 0 6 ) u s e 2 5 . 0 0 = I τ .

Mendoza, Razin, and Tesar (1994) estimate effective labor income tax rates in the 26-28 percent range for the US, the UK, Canada and Japan in 1988 (the last year for which they do this exercise). Their estimates are much higher for the other industrial countries included in their sample (reaching 47 percent for France). However, considering that in many emerging markets (such as those which have recently moved towards the flat tax) income tax rates are

m u c h l o w e r , w e b e l i e v e t h a t 2 0 . 0 0 = I τ p e r c e n t i s a n a p p r o p r i a t e p a r a m e t e r i z a t i o n f o r o u r exercises, which aim at starting from a somewhat standard fiscal stance. Similar c o n s i d e r a t i o n s w e r e m a d e i n t h e c h o i c e o f 0 8 . 0 0 = C τ . 9 I n s e c t i o n s I V , V a n d V I w e r e p o r t

and discuss the results of calibrations under this benchmark parameterization derived using the algorithm developed by Klein (2000) and McCallum (2001). In Section VI we present some sensitivity analysis experiments in which we look at the implications of a wider range of variation for the labor disutility and nominal rigidity parameters.

IV. THE DOMESTIC AND INTERNATIONAL EFFECTS OF A CUT IN THE INCOME TAX RATE

In this section we analyse the implications of an unexpected reduction in the income tax rate I t τ f r o m 0 . 2 ( a 2 0 p e r c e n t i n c o m e t a x r a t e ) t o 0 . 1 9 ( a 1 9 p e r c e n t i n c o m e t a x r a t e ) , w h i c h

corresponds to a 5 percent cut in the rate. Since we want to initially focus on the macroeconomic and budgetary implications of income tax reform abstracting from changes

i n o t h e r t a x e s , w e l e a v e t h e c o n s u m p t i o n t a x r a t e C t τ u n c h a n g e d a t i t s i n i t i a l s t e a d y s t a t e l e v e l of 0.08 (an 8 percent consumption tax rate) in this section.10

The results of this policy exercise are presented in Figure 1. The vertical axes show percentage deviations from the initial steady state. For variables whose initial steady-state value is zero, deviations are expressed in relation to initial output. Figure 1 shows the response of domestic and foreign macroeconomic variables (including total revenue collection). Although much of the public opinion debate on the budgetary implications of tax reforms is cast in terms of the impact on nominal revenue collection, what ultimately matters for the government ability to carry out its functions is the amount of real resources available to the public sector. Since, unlike most of the papers which have looked at similar issues, we use a monetary model with nominal rigidity, we can analyze the response of both nominal revenue collection (NRC) and real revenue collection (RRC). Those are reported in Figure 1(e.g.) and can be derived from (5) as follows (using hats to denote log-deviations):

9 The estimate of effective tax rates on consumption made by Mendoza, Razin, and Tesar (1994) vary from about 5 percent for the US and Japan to about 21 percent for France.

10

In section V we consider the case of changes in the consumption tax rate.

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