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Giovanni Ganelli and Juha Tervala - page 14 / 32

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) ˆ ˆ ˆ ) ( 1 ( ) ˆ ˆ ˆ ( ˆ t t C t t I t P C u l w u R C N + + + + + = τ τ

(21)

) ˆ ˆ ) ( 1 ( ) ˆ ˆ ˆ ˆ ( ˆ t C t t t I t C u P l w u R C R + + + + = τ τ

(22)

where u denotes the share of income tax on total taxes in the initial steady state (in our benchmark parameterization this share is equal to 0.7, see Appendix for the derivation).

ˆ E q u a t i o n s ( 2 1 ) a n d ( 2 2 ) r e f e r t o t o t a l r e v e n u e c o l l e c t i o n . I n e q u a t i o n ( 2 1 ) , ) ˆ ˆ ( t t I t l w u + + τ

d e n o t e s n o m i n a l i n c o m e t a x c o l l e c t i o n , w h i l e ) ˆ ˆ ˆ ( t t C P C u + + τ d e n o t e s n o m i n a l c o n s u m p t i o n

tax collection. Real income and consumption tax collection are derived in an analogous way in equation (22).

Figure 1(d) also includes the response of the domestic terms of trade, defined as the Calvo- weighted relative price of domestic exports in terms of domestic imports. Thus the increase in Figure 1(d) implies an improvement of the domestic terms of trade in the short run.

Figure 1. The Effects of a Domestic Income Tax Reduction

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