By Stéphane Auray, Aurélien Eyquem and Xiaofei Ma
We quantify the effects of competitive tax reforms within a two-country monetary union model with endogenous entry and endogenous tradability. As expected, their effects on output , consumption, hours worked and the terms of trade are positive. Extensive margins provide additional transmission mechanisms that turn the response of foreign output from negative to positive and yields larger aggregate welfare gains compared to alternative models. These positive spillovers are due to the positive effect of the reform on variety creation in both countries and change our vision of this type of reform from beggar-thy-neighbor to prosper-thy-neighbor.
Interesting to see that competitive tax reforms benefit both countries, and that an important channel in this is business creation. The analysis is limited to VAT and payroll tax, I wonder whether this extends to other dimensions of tax policy, including tariffs, corporate taxation and tax credits.