Do Consumption Tax Cuts Lead to Dynamic Laffer Effects in Open Economies?

Abstract

This paper extends benchmark OR model with consumption tax reform, based on “New open economy macroeconomics” framework, and analyzes res ponses of consumption tax reduction to output, consumption, exchange rate. Our analytical results show that a unilateral cut in consumption tax rate for domestic country results in a domestic depreciation, generates a domestic boom in which both output and consumption increase in the short-run and long-run. We focus on the dynamic Laffer effects to happen by numerical solutions from our derived analytical solutions, in the sense that it has positive budgetary consequences for the country which implements it. So both government and residents can get benefits from a consumption tax cut.