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18

V. CONSUMPTION TAX CUTS

In this section we look at a policy alternative to the one considered in the previous section, that is one in which the government decides to unexpectedly reduce the consumption tax rate

r a t h e r t h a n t h e l a b o r i n c o m e t a x r a t e . I n t h e p o l i c y e x p e r i m e n t t h a t w e p r e s e n t h e r e I t τ i s therefore kept constant at its initial steady-state level 0.2 (a 20 percent income tax rate) while t h e c o n s u m p t i o n t a x r a t e C t τ i s r e d u c e d f r o m 0 . 0 8 t o 0 . 0 7 ( f r o m 8 t o 7 p e r c e n t , w h i c h a m o u n t s

to a 12½ percent decrease in the rate). In addition to allowing us to investigate the issue of whether a consumption tax cut can deliver a “free” or a “cheap” lunch, the exercise presented in this section also makes possible a comparison with the one discussed in section IV, thus highlighting the different impact on domestic output and consumption, as well as on the foreign country, of alternative fiscal stimulus packages. The results of this exercise are summarized in Figure 2 and in Tables 4 and 5.

Figure 2. The Effects of a Domestic Consumption Tax Reduction

Table 4. Consumption Tax Rate Cut: Domestic Tax Revenues Collection Changes 1/

t=1

t=3

t=5

-2.4

-2.9

-2.9

Change in nominal tax revenues New steady state

  • -

    2.9

t=1

t=3

t=5

-2.8

-3.3

-3.4

Change in real tax revenues New steady state

  • -

    3.4

1/ Percentage changes with respect to the initial steady state.

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