The Open Economy

Abstract

This chapter extends the basic model into a two-country framework. Since the work of Feldstein (1978), Bradford (1980a, 1980b), Mieskowski (1980), and Summers (1981b) among others, the consumption tax policy has gained considerable support in the last decade or so. Section 2 demonstrates the results of the conventional wisdom. In an open economy, a switch from the income tax to the consumption tax increases capital accumulation, reduces the interest rate, and improves welfare in the world-wide economy. Next, this section investigates the positive spillover welfare effect of tax reform in the home country on the foreign country. Since our main concern in this chapter is to extend the results in previous chapters into a two-country open-economy framework, for simplicity we will mainly consider the long-run properties.