Ellen R. McGrattan - Monetary Advisor
Published October 1, 2004
With a monetary union in place, many European countries are now debating if and how to coordinate their tax policies. Of particular interest to EU ministers is taxation of mobile factors like capital. Mendoza and Tesar (MT) use a game-theoretic approach to address the question, What is the outcome of tax competition and tax coordination when countries choose the tax on capital income and adjust other tax rates to keep revenues constant? MT predict very large welfare gains (losses) to tax competition for European countries that had high (low) tax rates prior to financial integration. In particular they predict a large gain for the United Kingdom and a large loss for countries in continental Europe. A second finding is that the welfare gains of tax coordination relative to that of tax competition are small. I discuss these findings in light of current policy debates and possible future extensions of this work.
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