Open Economies Review

, Volume 25, Issue 2, pp 373–406 | Cite as

Unanticipated vs. Anticipated Tax Reforms in a Two-Sector Open Economy

  • Olivier Cardi
  • Romain Restout
Research Article


We use a two-sector neoclassical open economy model with traded and non-traded goods to investigate the effects of unanticipated and anticipated tax reforms. First, an unanticipated tax reform produces an expansion of GDP, labor, and investment, while an anticipated tax reform has opposite effects before the implementation of the labor tax cut. Quantitatively, if the traded sector is more capital intensive, GDP increases by 1.6 percentage points or declines by 2.7 percentage points after three years, depending on whether the tax cut is unanticipated or anticipated. Second, we find that GDP change masks a wide dispersion in sectoral output responses. As long as investment is both traded and non traded, a tax reform substantially raises the relative size of the non-traded sector after three years while traded output always drops. Third, a tax reform improves welfare in all scenarios, more so if the markup is endogenous, but less so if the shock is anticipated. Importantly, we find that welfare gains in a two-sector economy with capital accumulation and perfect access to external borrowing are between 39 % and 89 % higher than those in an economy without physical capital.


Non traded goods Investment Tax reform Anticipation effects Current account 

JEL Classifications

F41 E62 E22 F32 


  1. Altissimo F, Benigno P, Palenzuela DR (2011) Inflation differentials in a currency area: facts, explanations and policy. Open Econ Rev 22:189–233CrossRefGoogle Scholar
  2. Atolia M, Buffie EF (2011) Solving the unit root problem in models with an exogenous world market interest rate. Macroecon Dyn 15(5):681–712CrossRefGoogle Scholar
  3. Auerbach AJ (2011) Long-term fiscal sustainability in major economies. Mimeo, University of California, BerkeleyGoogle Scholar
  4. Baxter M, King RG (1993) Fiscal policy in general equilibrium. Am Econ Rev 83(3):315–334Google Scholar
  5. Bems R (2008) Aggregate investment expenditures on tradable and nontradable goods. Rev Econ Dyn 4:852–883CrossRefGoogle Scholar
  6. Benetrix A, Lane PR (2010) Fiscal shocks and the sectoral composition of output. Open Econ Rev 21(3):335–350CrossRefGoogle Scholar
  7. Cerra V, Tekin S, Turnovsky SJ (2009) Foreign transfers and real exchange rate adjustments in a financially constrained dependent economy. Open Econ Rev 20(2):147–181CrossRefGoogle Scholar
  8. Cloyne J (2013) Discretionary tax changes and the macroeconomy: new narrative evidence from the United Kingdom. Am Econ Rev 103(4):1507–28CrossRefGoogle Scholar
  9. Coenen G, McAdam P, Straub R (2008) Tax reform and labour-market performance in the euro area: a simulation-based analysis using the new area-wide model. J Econ Dyn Control 32(8):2543–83CrossRefGoogle Scholar
  10. Coto-Martinez J, Dixon H (2003) Profits, markups and entry: fiscal policy in an open economy. J Econ Dyn Control 27(4):573–597CrossRefGoogle Scholar
  11. Domeij D, Flodén M (2006) The labor-supply elasticity and borrowing constraints: why estimates are biased. Rev Econ Dyn 9:242–262CrossRefGoogle Scholar
  12. Favero C, Giavazzi F (2012) Measuring tax multipliers: the narrative method in fiscal VARs. Am Econ J Econ Policy 4(2):69–94CrossRefGoogle Scholar
  13. Galí J (1995) Product diversity, endogenous markups, and development traps. J Monet Econ 36:39– 63CrossRefGoogle Scholar
  14. Heijdra BJ, Ligthart JE (2009) Labor tax reform, unemployment and search. Int Tax Public Financ 16:82–104CrossRefGoogle Scholar
  15. House CL, Shapiro MD (2006) Phased-in tax cuts and economic activity. Am Econ Rev 96(5):1835– 1849CrossRefGoogle Scholar
  16. Jaimovich N, Floetotto J (2008) Firm dynamics, markup variations and the business cycle. J Monet Econ 55:1238–1252CrossRefGoogle Scholar
  17. Kuralbayeva K, Vines D (2008) Shocks to terms of trade and risk-premium in an intertemporal model: the dutch disease and a dutch party. Open Econ Rev 19(3):277–303CrossRefGoogle Scholar
  18. Langot F, Patureau L, Sopraseuth T (2012) optimal fiscal devaluation. IZA Discussion Paper No. 6624Google Scholar
  19. Lucas RE (2003) Macroeconomic priorities. Am Econ Rev 93(1):1–14CrossRefGoogle Scholar
  20. McDaniel C (2007) Average tax rates on consumption, investment, labor and capital in the OECD 1950-2003. Mimeo.
  21. Mankiw GN, Rotemberg JJ, Summers LH (1985) Intertemporal substitution in macroeconomics. Q J Econ 100(1):225–251CrossRefGoogle Scholar
  22. Mendoza EG, Tesar L (1998) The international ramifications of tax reforms: supply-side economics in a global economy. Am Econ Rev 81(4):797–818Google Scholar
  23. Mertens K, Ravn MO (2012) Empirical evidence on the aggregate effects of anticipated and unanticipated us tax policy shocks. Am Econ J Econ Policy 4(2):145–81CrossRefGoogle Scholar
  24. Pedroni P (2001) Purchasing power parity tests in cointegrated panels. Rev Econ Stat 83(4):727–731CrossRefGoogle Scholar
  25. Perotti R (2011) The effects of tax shocks on output: not so large, but not so small either. NBER Working Paper n 0 16786Google Scholar
  26. Petrucci E, Phelps ES (2009) Two-sector perspectives on the effects of payroll tax cuts and their financing. J Public Econ 93:176–190CrossRefGoogle Scholar
  27. Roeger W (1995) can imperfect competition explain the difference between primal and dual productivity measures? estimates for U.S. manufacturing. J Polit Econ 103(2):316–330CrossRefGoogle Scholar
  28. Romer CD, Romer DH (2010) The macroeconomic effects of tax changes: estimates based on a new measure of fiscal shocks. Am Econ Rev 100:763–801CrossRefGoogle Scholar
  29. Schubert SF, Turnovsky SJ (2002) The dynamics of temporary policies in a small open economy. Rev Int Econ 10(4):604–622CrossRefGoogle Scholar
  30. Stockman AC, Tesar LL (1995) Tastes and technology in a two-country model of the business cycle: explaining international comovements. Am Econ Rev 85(1):168–185Google Scholar
  31. Turnovsky SJ, Sen P (1995) Investment in a two-sector dependent economy. J Jpn Int Econ 9:29–55CrossRefGoogle Scholar
  32. Wu Y, Zhang J (2000) Endogenous markups and the effects of income taxation: theory and evidence from OECD countries. J Public Econ 7:383–406CrossRefGoogle Scholar
  33. Yang SCS (2005) Quantifying tax effects under policy foresight. J Monet Econ 52(8):1557–1568CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York 2013

Authors and Affiliations

  1. 1.Université Panthéon-Assas Paris 2, ERMESParis Cedex 05France
  2. 2.Université de Lorraine, BETANancy CedexFrance

Personalised recommendations