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With the credit-channel effect driven by the central bank's open market operations, this paper's model easily gives rise to the nonlinear inflation-growth nexus, which is evidenced by a number of cross-country empirical studies. The threshold level of the inflation rate is found to be lower when tax rates are higher. The presence of the credit-channel effect also provides the rationale for setting positive (and smaller than 1) tax rates on consumption, tabor income, and capital income. The optimal tax rates rise as the inflation target declines. Under a fiscal policy rule where labor and capital income taxes move proportionally to each other, the optimal capital income tax rate could be higher than the optimal labor income tax rate. Under a sufficiently large central bank balance sheet, the credit-channel effect will be so weak that inflation and all kinds of taxes are growth and welfare repressing. This provides a rationale for central banks that have implemented quantitative easing policies to shrink their balance sheets. (JEL E58, E62, 042), I. INTRODUCTION The optimal long-run rate of inflation has long been the main concern of monetary policymakers and researchers; see Schmitt-Grohe and Uribe (2011) for an overview. This monetary issue [...]

This paper examines how Social Security dependent benefits impact the labor supply of married women aged 25-54. Specifically, I investigate whether the decrease in the rate of return to women's work discourages them from participating in the labor force by simulating expected net payroll tax rates and dependent benefits. Dependent benefits may reduce the net return to women's work, as they usually pay the full payroll tax without receiving marginal benefits for additional earnings if they claim benefits based on their husbands' earnings records. The results show that high net payroll tax rates reduce married women's work incentives, particularly those near retirement age. (JEL H24, H55, J22), I. INTRODUCTION Since 2010, Social Security's total expenditures have exceeded the noninterest income of its combined trust funds, and the deficit is expected to rise rapidly in the future with [...]

Canadian provinces are required to phase in a minimum price of CAN $50 per tonne on carbon dioxide emissions by 2022. This paper discusses the rationale for, and design of, the price floor requirement; its (provincial-level) environmental, fiscal, and economic welfare impacts; monitoring issues; and (national-level) industry incidence. The general conclusions that the welfare costs and implementation issues are manageable, and pricing provides significant new revenues. A challenge is that the floor price by itself is well short of what will be needed by 2030 for Canada's Paris Agreement pledge. Keywords: carbon price, price floor, Canada, welfare impacts, incidence, effective carbon price, competitiveness impacts JEL Codes: Q54, Q58, H23, 1. INTRODUCTION One hundred and ninety five parties submitted pledges to reduce carbon dioxide (C[O.sub.2]) and other greenhouse gases (GHGs)--so-called 'Nationally Determined Contributions' (NDCs)--for the 2015 Paris Agreement on climate [...]

What is the most physician friendly state? Every year, our partners at Physicians Practice[R] conduct an analysis of which states are the most physician friendly, using a variety of criteria [...]

I analyze the dynamic effects of tax competition on public budget deficits. I find that stronger tax competition leads to a fiscal deficit bias at the early stages of financial liberalization. When coun tries differ in terms of capital mobility, further liberalization leads to external imbalances and diverging fiscal deficits while corporate tax rates converge. Consistent with theory, I find that stronger tax competition increases deficits in a sample of OECD countries, controlling for tax revenues and other standard determinants of fiscal deficits. (JEL E62, F62), I. INTRODUCTION The effect of financial globalization on the governments' ability to redistribute is an important yet only partially understood issue. Starting in the mid-1980s, deregulation in the financial sector [...]

Within the literature on the informal sector, there has been numerous research on the impact of labour regulation and the tax rate on productivity on the size of the informal sector (IS) and unemployment. These effects have mostly been analysed with the aid of search and matching models. However, we have observed, that the impact of labour regulation on the size of the informal sector and unemployment rate has not been estimated empirically. On the other hand, the effect of the tax rate on the size of the informal sector has been analysed with the aid of various theoretical and empirical models respectively. Our paper attempts to bridge the gap in the theoretical and empirical literature by demonstrating that a change in firing costs generates a trade off in the decision to operate in the informal sector or become unemployed. However, an increase in the tax rate on production can neutralise the impact of higher firing costs on unemployment. We use a dynamic general equilibrium model to show how a change in firing costs or tax rate affects the incentive of an agent to operate in the informal sector as well as the consequences for unemployment. The model's parameters are calibrated with values used in the general literature to demonstrate analytically the impact of firing costs and the tax rate on the size of the informal sector and unemployment. Our results show that an increase in firing costs decreases the relative size of the IS but raises the unemployment rate. However, a rise in the tax rate increases the relative size of the informal sector but reduces the unemployment rate. Next, we apply panel data analysis to estimate the effect of firing costs and direct tax for a panel of 93 countries between 2000 and 2007. We find that our empirical results are consistent with the results from our theoretical model. Our results reveals how the kind of regulation (labour or non-labour) can have a direct impact on the mobility of factors of production between the formal and informal sector respectively. It also shows how regulatory policy can be refined to maximize the trade-off between the informal sector and unemployment. JEL Classifications: J41, O17 Keywords: Firing cost, Informal sector, Tax burden, Unemployment, Labor regulation, Shadow Economy, INTRODUCTION Our paper estimates the effect of firing costs on the size of the informal sector (IS) and the unemployment rate. We show that higher firing costs has a significant [...]

The root of the Baumol cost disease is higher productivity increases for manufactured goods than for services. The implied increase in relative costs of service production is widely claimed to have devastating implications for the public sector as a provider of tax-financed services such as health, education, and care. To match the increasing costs it appears inevitable that tax rates would be ever increasing. It is shown that this inference does not follow under standard assumptions when accounting explicitly for service provision from both the private and public sectors. Strikingly under assumptions often made in the literature, the welfare maximizing tax rate for a utilitarian policy maker would remain constant despite the Baumol cost disease, and by implication the share of public employment in total employment will remain constant. (JEL H5, H11, O41), I. INTRODUCTION The origin of the Baumol cost disease is lower (none) productivity growth for services than for manufactures (the 'progressive' sector), see Baumol and Brown (1966) and Baumol (1967). [...]

I examine how taxes and tax progressivity affect two different types of entrepreneurship--established business ownership and nascent entrepreneurship--in a large group of Organization for Economic Co-operation and Development countries, using 2000-2009 macro-level Global Entrepreneurship Monitor data. Empirical evidence from Arellano-Bond generalized method of moments estimation suggests that higher tax progressivity exerts a negative influence on nascent enterprises but appears to have no impact on established business ownership. Changes in marginal and average tax rates are found to have no significant influence on either type of entrepreneurship. The most important contribution of the article is the comparison of tax impacts on actual and nascent entrepreneurship rates. (JEL H24, H29, M13, M19), I. INTRODUCTION In recent years, there have been heated debates in the United States (1) and some European Union countries about taxation and economic growth. There are people who believe [...]

This article examines the determinants of local tax rates. For the two main local taxes in Spain--the property tax and the motor vehicle tax--we test the existence of tax mimicking, yardstick competition, and political trends in a sample of 2,713 municipalities. Using various spatial models, the results support the hypothesis of tax mimicking, with coefficients above 0.40. We also show the relevance of political variables such as the ideology of incumbents and political fragmentation. The fact that incumbents with weaker political support exhibit stronger mimicking behavior is interpreted as evidence in favor of yardstick competition. Finally, we find that incumbents mimic neighboring municipalities ruled by the same political party, confirming the political trends hypothesis. (JEL C31, H71, H77), I. INTRODUCTION Local tax rates are determined by a wide range of economic and political factors, both internal and external to a municipality. Among the external factors are changes in [...]

Introduction and summary Fiscal policy describes how the expenditure and revenue decisions of local, state, or federal governments influence economic growth. In this article, we create a comprehensive measure of [...]

We review the empirical literature on competition in source-based taxes on corporate income. Drawing an analogy to the competition models for the goods market indicates how evidence for the existence of tax competition can be provided, and highlights that tax competition can take many forms. With this in mind we classify the empirical literature, and highlight the importance of the measurement of tax rates and openness. Using measures based on the statutory tax system, there is evidence for tax competition mostly in the European Union. In contrast to the view of Gordon (1992) small countries appear to be the leader of the tax competition game. Keywords: tax competition, corporate taxation JEL Codes: H25, H21, I. INTRODUCTION In the last two decades, both policy makers and academics have been increasingly occupied with tax competition. Policy makers have been concerned about a race to the bottom [...]

We review the basics of international tax planning by U.S. multinational corporations (MNCs) and the organizational structures that facilitate such planning. We then discuss the potential impacts that adopting a participation exemption regime (i.e., a territorial tax system) along the lines proposed by Representative Camp could have on a U.S. MNC's worldwide supply chain structure and financing arrangements. We compare the change in a corporation's global accounting effective tax rate under the current U.S. worldwide tax system and four participation exemption options proposed by Representative Camp. Using a hypothetical set of facts representative of a U.S. multinational with highly mobile intellectual property income, we show that the options produce very different accounting effective tax rates and tax revenues received by the U.S. Treasury. We also point out potential tax planning strategies that could be employed pre- and post-effective date of the implementation of a participation exemption system that would change the expected revenue to be received during the transition to such a system. Keywords: international taxation, tax reform, territorial tax system JEL Codes: H25, H26, M41, M48, I. INTRODUCTION The call for international corporate tax reform has gained traction in the past two years, with the chairs of both tax writing committees pledging to craft comprehensive tax [...]

This paper compares the employment growth of states that enacted corporate income tax rate cuts in the past 23 years with those making no changes. Overall employment comparisons from 1990 [...]

We analyze the sustainability of the government's intertemporal budget constraint and the corresponding fiscal reaction function within a nonlinear error-correction framework. Our empirical analysis, based on Italy, provides some evidence that the Italian government is meeting its intertemporal budget constraint. Nevertheless, we show that the burden of correcting budgetary disequilibria is entirely carried out by changes in the average tax rate, with a weakly exogenous government spending, possibly determined by the political process. We also document some rigidities of the tax instrument, in terms of downward inflexibility of the average tax rate with respect to its long-run level. Finally, we provide some evidence in favor of a nonlinear adjustment toward a sustainable long-run equilibrium, as the average tax rate adjusts faster the further away it gets from the equilibrium. By considering the behavior of taxes across the economic cycle, we also provide some evidence of inflexibility of the tax instrument during bad times. (JEL C32, C51, C52, H20, H50), I. INTRODUCTION Fiscal policy sustainability is an important issue for European Union (EU) countries, which are subject to some forms of monitoring of their public finances. The European Stability and [...]

The foreign share of the worldwide income of U.S. multinational corporations (MNCs) has risen sharply in recent years. Data from a panel of 754 large MNCs indicate that the MNC foreign income share increased by 14 percentage points from 1996 to 2004. The differential between a company's U.S. and foreign effective tax rates exerts a significant effect on the share of its income abroad, largely through changes in foreign and domestic profit margins rather than a shift in sales. U.S. foreign tax differentials are estimated to have raised the foreign share of MNC worldwide income by about 12 percentage points by 2004. Lower foreign effective tax rates had no significant effect on a company's' domestic sales or on the growth of its worldwide pre-tax profits. Lower taxes on foreign income do not seem to promote 'competitiveness.' Keywords: multinational corporations, domestic-foreign tar differentials, income shifting, foreign-source income JEL Codes: F23, H25, H32, Since 1996 there has been a significant increase in the share of the worldwide income of U.S. multinational corporations (MNCs) that is declared abroad. In a linked sample of large [...]

This article investigates the cyclical properties of the average effective tax rate in 26 OECD countries over 1965-2003 to test the validity of three theories of fiscal policy: (i) the standard Keynesian theory, which recommends that tax policy should be countercyclical: (ii) the Tax Smoothing hypothesis, which implies that changes in GDP should be uncorrelated with tax rates: and (iii) the positive theory of Battaglini and Coate (2008), which predicts the average tax rate should be negatively correlated with GDP. Our main finding is that the correlations of tax rates with cyclical GDP are generally quite small and statistically indistinguishable from zero. This finding is quite robust and is more consistent with the implications of the Tax Smoothing hypothesis than either the recommendations of the standard Keynesian model or predictions of the political economy theory of Battaglini and Coate. JEL Classification: E62, E32, 1. Introduction Is fiscal policy procyclical? Should it be? The standard Keynesian model implies that fiscal policy should be countercyclical, that is, government spending should increase in economic contractions and [...]

We show that firms successfully attempt to time exchangeable debt offerings. A firm that issues exchangeable debt gives the bondholders the option to exchange their bonds for shares of the underlying firm in which the issuing firm has a stake. Companies tend to raise cash with exchangeable debt soon after the underlying stock has appreciated, but issuers expect deterioration in the future performance of the underlying firm. The price of the underlying asset falls after the exchangeable debt is issued. An exchangeable debt issue also signals the prospective open market sale of the underlying shares by the issuer., Introduction Exchangeable debt is bonds issued by one company that are convertible into common shares of a second company (hereafter the underlying firm) in which the issuing firm has a [...]

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1475-4932.2010.00654.x Byline: RATBEK DZHUMASHEV (1), EMIN GAHRAMANOV (2) Keywords: H26; D91; O41 Abstract: We develop an endogenous growth model a la Barro (1990), augmented with income tax evasion. Unlike many traditional rational choice models of tax evasion, the numerical simulations of our model do not produce counter-intuitive results. Further, we show that: (i) accounting for evasion costs (while capturing the full risk associated with the tax evasion process) is important for obtaining realistic relationships between key model variables; (ii) productive government expenditures explicitly affect the economy's tax evasion rate; (iii) Barro's natural efficiency condition for setting the optimal statutory tax rate holds even in the presence of tax evasion; (iv) given realistic estimates of the public expenditure externality, the average marginal income tax rate in Australia is not too far away from the optimal one; and (v) differences in tax evasion opportunities aggravate inequality over time. Author Affiliation: (1)Department of Economics, Monash University, Berwick, Victoria, Australia (2)School of Accounting, Economics and Finance, Deakin University, Burwood, Victoria, Australia Article note: Emin Gahramanov, School of Accounting, Economics and Finance, Deakin University Burwood campus, 70 Elgar Road, Melbourne, VIC 3125, Australia. Email: eming@deakin.edu.au

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1467-9957.2009.02150.x Byline: TSUYOSHI TOSHIMITSU (1) Abstract: Based on a model of environmental quality differentiated products, we explore how an emission tax charged on consumers who choose an environment-unfriendly good, i.e. a consumer-based emission tax policy, affects the unit emission level of the product, the environment, and consumer and producer surplus. Then, we analyse the conditions for an optimal consumer-based emission tax rate to exist and the properties of the optimal tax rate. We address these issues in the case of a partial coverage market with a Bertrand duopoly. Furthermore, we discuss some of the assumptions of the model. Author Affiliation: (1)Kwansei Gakuin University

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jmateco.2010.08.005 Byline: Stefano Bosi (a), Thomas Seegmuller (b) Keywords: Progressive taxation; Heterogeneous agents; Borrowing constraint; Endogenous labor supply; Steady state allocation; Macroeconomic stability Abstract: The aim of this paper is to study the role of progressive tax rules on the steady state and the stability properties in a Ramsey economy with heterogeneous households and borrowing constraints. Since labor supply is elastic, considering different tax rates on capital and labor incomes matters. Showing the existence of steady states where only the most patient households hold capital, we argue that working could not be optimal for them. Dynamics are addressed through a local analysis. In contrast to many contributions, progressive tax rules can promote expectation-driven fluctuations and endogenous cycles. Hence, progressivity can be an inopportune device to stabilize macroeconomic volatility. Author Affiliation: (a) THEMA, Universite de Cergy-Pontoise, 33 boulevard du Port, 95011 Cergy-Pontoise Cedex, France (b) CNRS and GREQAM, Centre de la Vieille Charite, 2 rue de la Charite, 13236 Marseille Cedex 02, France Article History: Received 20 May 2009; Revised 4 August 2010; Accepted 4 August 2010 Article Note: (footnote) [star] This work was supported by French National Research Agency Grant (ANR-05-BLAN-0347-01). Part of this research has been done when Stefano Bosi was at the University of Lille 1 and Thomas Seegmuller at the Paris School of Economics. We would like to thank an anonymous referee for his helpful comments and the participants of the workshop 'Growth with Heterogeneous Agents: Causes and Effects of Inequality' held in Marseille on June 2008, of the Public Economic Theory conference held in Seoul on June 2008, of the 'First Workshop on Dynamics, Optimal Growth and Population Change: Theory and Applications' held in Milan on September 2008 and of the Western Economic Association International conference held in Kyoto on March 2009. This paper also benefits from suggestions by Carine Nourry. All remaining errors or omissions are our own.

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1468-2354.2010.00611.x Byline: Thomas Aronsson ([dagger]), Olof Johansson-Stenman (1) Abstract: This article concerns optimal income taxation under asymmetric information in a two-type OLG model when individuals' relative consumption matters. Positional concerns affect the policy choices via two channels: (i) the average degree of positionality and (ii) positionality differences between the low-ability type and the mimicker. Under plausible empirical estimates, the marginal labor income tax rates become substantially larger, and the absolute value of the marginal capital income tax rate of the low-ability type becomes substantially smaller, than in the conventional model. In addition to measures of reference consumption based on average consumption, we also address within-generation and upward comparisons. Author Affiliation: ([dagger])Umea University, Sweden; University of Gothenburg, Sweden

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1540-5982.2010.01610.x Byline: Karen Pittel (1), Lucas Bretschger (1) Keywords: O4; O41; Q01; Q3 Abstract: Abstract. We analyze the long-term dynamics of an economy in which sectors are heterogeneous with respect to the intensity of natural resource use. It is shown that heterogeneity induces technical change to be biased towards resource-intensive sectors. Along the balanced growth path, the sectoral structure of the economy is constant as the higher resource dependency in resource-intensive sectors is compensated by enhanced research activities. Resource taxes have no impact on dynamics except when the tax rate varies over time. Research subsidies and the sectoral provision of productivity-enhancing public goods raise growth and provide an effective tool for structural policy. Abstract (Spanish): Les implications de l'heterogeneite des intensites dans l'usage des ressources naturelles sur le changement technique et la croissance. On analyse la dynamique a long terme d'une economie dans laquelle les secteurs sont heterogenes pour ce qui est de l'intensite dans l'usage des ressources naturelles. On montre que cette heterogeneite engendre un changement technique biaise dans la direction des secteurs a forte intensite dans l'usage de la ressource naturelle. Le long d'un sentier de croissance balancee, la structure sectorielle de l'economie est constante a proportion que la dependance plus grande de la ressource dans les secteurs a forte intensite d'utilisation de la ressource est compensee par des activites de recherche plus importantes. Les taxes sur la ressource n'ont pas d'effet sur la dynamique si ce n'est quand les taux de taxation varient dans le temps. Les subventions a la recherche et la production de biens publics qui renforcent la productivite sectorielle augmentent la croissance et sont un outil efficace de politique structurelle. Author Affiliation: (1)Center of Economic Research, ETH Zurich

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2010.04.006 Byline: Hubert Kempf (a), Gregoire Rota-Graziosi (b) Keywords: Endogenous timing; Tax competition; First/second-mover advantage; Strategic complements; Stackelberg; Risk-dominance Abstract: In this paper we extend the standard approach of horizontal tax competition by endogenizing the timing of decisions made by the competing jurisdictions. Following the literature on the endogenous timing in duopoly games, we consider a pre-play stage, where jurisdictions commit themselves to move early or late, i.e. to fix their tax rate at a first or second stage. We highlight that at least one jurisdiction experiments a second-mover advantage. We show that the Subgame Perfect Equilibria (SPEs) correspond to the two Stackelberg situations yielding to a coordination problem. In order to solve this issue, we consider a quadratic specification of the production function, and we use two criteria of selection: Pareto-dominance and risk-dominance. We emphasize that at the risk-dominant equilibrium the less productive or smaller jurisdiction leads and hence loses the second-mover advantage. If asymmetry among jurisdictions is sufficient, Pareto-dominance reinforces risk-dominance in selecting the same SPE. Three results may be deduced from our analysis: (i) the downward pressure on tax rates is less severe than predicted; (ii) the smaller jurisdiction leads; (iii) the 'big-country-higher-tax-rate' rule does not always hold. Author Affiliation: (a) Paris School of Economics and Banque de France, France (b) CERDI-CNRS, Universite d'Auvergne, France Article History: Received 23 September 2009; Revised 24 February 2010; Accepted 19 April 2010

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jedc.2010.06.017 Byline: Lorenzo Forni (a)(b), Andrea Gerali (b), Massimiliano Pisani (b) Abstract: We simulate a currency union dynamic general equilibrium model to assess the macroeconomic implications of permanently reducing the public debt-to-gross domestic product (GDP) ratio in euro area countries. We obtain the following results. First, tax distortions are quantitatively significant. Second, the best fiscal consolidation strategy is to permanently reduce both expenditures and tax rates. Third, under such a consolidation strategy the transition is generally not costly, as the GDP and investment would grow, while private consumption would not fall. Finally, spillovers to the rest of the euro area are generally expansionary. Author Affiliation: (a) International Monetary Fund, Washington, DC, USA (b) Bank of Italy, Forecasting and Modeling Division, Italy

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jet.2009.09.003 Byline: Borys Grochulski (a), Tomasz Piskorski (b) Keywords: Optimal taxation; Private information; Human capital; Deferred tax Abstract: We study the structure of optimal wedges and capital taxes in a dynamic Mirrlees economy with endogenous distribution of skills. Human capital is a private, stochastic state variable that drives the skill process of each individual. Building on the findings of the labor literature, we construct a tractable life-cycle model of human capital evolution with risky investment and stochastic depreciation. In this setting, we demonstrate the optimality of (a) a human capital premium, i.e., an excess return on human capital relative to physical capital, (b) a large intertemporal wedge early in the life-cycle, and (c) a non-zero intratemporal wedge even at the top of the skill distribution at all dates except the last date in the life-cycle. The main implication for the structure of optimal linear capital taxes is the necessity of deferred taxation of physical capital. The average marginal tax rate on physical capital held in every period is zero in present value. However, expected capital tax payments do not equal zero in every period. Necessarily, agents face negative expected capital tax payments early in the life-cycle and positive expected capital tax payments late in the life-cycle. Author Affiliation: (a) Federal Reserve Bank of Richmond, United States (b) Columbia University, Columbia Business School, Broadway 3022, Uris Hall 810, New York, NY 10027, United States Article History: Received 28 December 2007; Revised 12 June 2009; Accepted 30 August 2009 Article Note: (footnote) [star] The views expressed here are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2009.10.002 Byline: Peter Egger (a)(b)(c), Marko Koethenbuerger (b)(d), Michael Smart (b)(e) Keywords: Fiscal competition; Fiscal federalism; Equalization; Gewerbesteuer Abstract: According to theory, capacity equalization grants cause local governments to internalize the effects of their tax policies on revenues of neighboring jurisdictions and so raise equilibrium tax rates. This paper empirically analyzes the incentive effects of equalizing transfers on business tax policy by exploiting a natural experiment in the state of Lower Saxony which changed its equalization formula as of 1999. We resort to within-state and across-state difference-in-difference estimates to identify the reform effect on municipalities' business tax rates. Confirming the theoretical prediction, the reform had a significant impact on the municipalities' tax policy in the 4years after the reform with the effect stabilizing in the fourth to fifth years. The finding is robust to various alternative specifications. Author Affiliation: (a) Department of Economics, ETH Zurich, Weinbergstrasse 35, 8006 Zurich, Switzerland (b) CESifo, Germany (c) CEPR, United Kingdom (d) Department of Economics, University of Copenhagen, Aster Farimagsgade 5, 1353 Copenhagen, Denmark (e) Department of Economics, University of Toronto, 150 St. George Street, Toronto ON M5S 3G7, Canada Article History: Received 11 January 2007; Revised 29 September 2009; Accepted 5 October 2009

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jet.2009.10.013 Byline: Andreas Schabert (a)(b) Keywords: Equilibrium determination; Interest rate policy; Money supply; Public debt; Sovereign default Abstract: This paper examines equilibrium determination under different monetary policy regimes when the government might default on its debt. We apply a cash-in-advance model where the government does not have access to non-distortionary taxation and does not account for initial outstanding debt when it sets the income tax rate. Solvency is then not guaranteed and sovereign default can affect the return on public debt. If the central bank sets the interest rate in a conventional way, the equilibrium allocation cannot be determined. If, instead, money supply is controlled, the equilibrium allocation can uniquely be determined. Author Affiliation: (a) TU Dortmund University, Germany (b) University of Amsterdam, Netherlands Article History: Received 1 June 2009; Revised 1 September 2009; Accepted 26 September 2009 Article Note: (footnote) [star] The author would like to thank Roel Beetsma, Wouter den Haan, Mark Gertler, Philipp Harms, Dirk Niepelt, Leopold von Thadden, and other seminar participants at the Federal Reserve Bank of New York, the Free University Berlin, and the University of Amsterdam for helpful comments. This work has been supported in part by the Collaborative Research Center SFB 823 of the German Research Foundation (DFG). The usual disclaimer applies.

The effects of demographics on the mix of tax rates on labor and capital are examined. The younger US voting-age population in 1990 compared to 1965 has explained for the decline in relative capital tax rate between those two years. The younger population has increased net return to capital, led voters to increase their savings, and resulted in preference for lower taxes on capital.

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1468-0297.2009.02333.x Byline: Teresa Garcia-Mila (1), Albert Marcet (2), Eva Ventura (3) Abstract: We evaluate the effect on welfare of shifting the burden of capital income taxes to labour taxes in a dynamic equilibrium model with heterogeneous agents and constant tax rates. We calibrate and simulate the economy; we find that lowering capital taxes has two effects: it increases efficiency in terms of aggregate production and it redistributes wealth in favour of those agents with a low wage/wealth ratio. When the parameters of the model are calibrated to match the distribution of income in terms of the wage/wealth ratio, the redistributive effect dominates, and agents with a high wage/wealth ratio would experience a large loss in utility if capital income taxes were eliminated. Author Affiliation: (1)Universitat Pompeu Fabra and Barcelona GSE (2)Universitat Autonoma de Barcelona, CEPR and Barcelona GSE (3)Universitat Pompeu Fabra and Barcelona GSE Article History: Submitted: 30 July 2008 Accepted: 28 May 2009

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jedc.2009.09.010 Byline: Tino Berger (a)(b), Gerdie Everaert (b) Abstract: This paper estimates the impact of labour taxes on unemployment using a panel of yearly observations (1970-2005) for 16 OECD countries. Possible heterogeneity of the unemployment incidence of taxes is taken into account by grouping countries according to their wage-setting institutions. Panel data unit root and cointegration tests show that unemployment and labour tax rates are non-stationary but not cointegrated. As this finding may be induced by missing non-stationary variables, we set up a panel unobserved component model. Labour taxes are found to have a positive impact on unemployment only in countries characterised by strong but decentralised unions. Author Affiliation: (a) Department of Economics, University of Muenster, Germany (b) SHERPPA, Ghent University, Belgium Article History: Received 21 May 2008; Accepted 17 September 2009

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1540-5982.2009.01570.x Byline: Celine Azemar (1) Keywords: F23; H25; H32 Abstract: Abstract. This paper explores the effects of corporate taxation on U.S. capital invested abroad and on tax planning practices. The econometric analysis first indicates that investment is strongly influenced by average tax rates, with a magnified impact particularly for low-tax rates, implying that the attractiveness of low-tax countries is not weakened by anti-deferral rules and cross-crediting limitations. Further explorations suggest that firms report higher profit, higher Subpart F income, and are less likely to repatriate dividends when they are located in low-tax jurisdictions. Finally, when the role of effective transfer pricing regulations is estimated, it appears that low degrees of law enforcement are associated with higher income shifting. Abstract (Spanish): Fiscalite internationale et comportment des firmes multinationales americaines: une approche integree. Ce memoire s'interesse aux effets des impots sur le revenu des societes sur l'investissement et les pratiques de planifications fiscales des firmes multinationales americaines. L'analyse econometrique indique que l'investissement americain est fortement influence par le taux d'imposition moyen et que cet impact est sensiblement plus important pour de faibles taux d'imposition. Ceci suggere que l'attractivite des pays a faible imposition n'est pas affaiblie par les limites imposees par le systeme fiscal americain sur la possibilite de differer l'impot et sur les moyennes de credit. Des tests additionnels montrent que les firmes reportent un profit ainsi qu'un revenu 'Subpart F' plus important et rapatrient moins leurs dividendes lorsqu'elles sont localisees dans des pays a faible imposition. Finalement, en estimant le role joue par l'efficacite des reglementations en termes de prix de transferts, il apparait qu'un faible etat de droit est associea de plus fortes manipulations fiscales. Author Affiliation: (1)Department of Economics, University of Glasgow

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2009.09.007 Byline: Pascalis Raimondos-MA[cedilla]ller (a)(b)(c), Nicolas Schmitt (c)(d) Keywords: Parallel import; Commodity taxation; Tax harmonization Abstract: We examine the interaction between commodity taxes and parallel imports in a two-country model with imperfect competition. While governments determine non-cooperatively their commodity tax rate, the volume of parallel imports is determined endogenously by the retailing sector. We compare the positive and normative implications of having commodity taxes based on destination or origin principle. We show that, as the volume of parallel imports increases, non-cooperative origin taxes converge, while destination taxes diverge. Moreover, origin taxes are more similar and lead to higher aggregate welfare levels than destination taxes. Author Affiliation: (a) Department of Economics, Copenhagen Business School, Porcelanshaven 16A, 2000 Frederiksberg, Denmark (b) CEPR, United Kingdom (.sup.c ) CESifo, Germany (.sup.d ) Simon Fraser University, Canada Article History: Received 26 October 2007; Revised 17 September 2009; Accepted 22 September 2009

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1475-4932.2009.00592.x Byline: ANN HARDING (1), QUOC NGU VU (1), ALICIA PAYNE (1), RICHARD PERCIVAL (1) Keywords: H20; H24; H53; I38; J16 Abstract: This article reviews trends in effective marginal tax rates (EMTRs) from 1996-1997 to 2006-2007 for working-age Australians. Although sweeping income tax cuts reduced effective tax rates for many taxpayers, the extension of income-tested welfare payments and tax concessions worked in the opposite direction. The proportion of working-age Australians facing EMTRs of more than 50 per cent increased during the period, from 4.8 to 7.1 per cent, representing some 910,000 Australians. This article also provides the first international comparisons of how the distribution of EMTRs for earners in Australia compares with those prevailing in Europe. Author Affiliation: (1) National Centre for Social and Economic Modelling, University of Canberra, Canberra, Australia Article note: Ann Harding, NATSEM, University of Canberra, ACT 2601, Australia. Email: ann.harding@canberra.edu.au

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.regsciurbeco.2009.07.004 Byline: Jeremy R. Groves Keywords: Property tax; Property tax incidence; Duration analysis; Urban growth; Sprawl Abstract: To date, few empirical studies have focused on the location decision by residential developers in response to changes in the property tax. Based on a dynamic time-to-development model by Turnbull, this paper finds, using 17 years of parcel level data from Saint Louis County, Missouri, that higher than average tax rates increase the time-to-development for vacant parcels by between 4 and 11%, all else equal. Additionally this paper finds that the tax differential effect is cumulative, resulting in about a 20% increase in the time-to-development for the parcel facing the average number of years with a higher than average rate. These results support the analytical results by both Turnbull [Turnbull, G.K., 1988. The effects of local taxes and public services on residential development patterns. Journal of Regional Science, 28 (4), 541-562.] and McMillen [McMillen, D.P., 1990. The timing and duration of development tax rate increases. Journal of Urban Economics, 28, 1-18.] that the property tax can distort residential capital markets leading to inefficient urban growth, or sprawl. Author Affiliation: Northern Illinois University, Department of Economics, DeKalb, IL 60115, United States Article History: Received 6 March 2009; Revised 13 July 2009; Accepted 14 July 2009 Article Note: (footnote) [star] The author wishes to thank participants at the NIU weekly seminar series, participants at the 2007 Regional Science Association International Annual Conference and several referees. Special thanks are extended to William Rogers, Paul Thorsnes and Virginia Wilcox-Gok for their detailed comments. All errors are mine.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2009.07.005 Byline: Dhammika Dharmapala (a), James R. Hines (b) Keywords: Tax havens; Foreign direct investment; Governance quality Abstract: This paper analyzes the factors influencing whether countries become tax havens. Roughly 15% of countries are tax havens; as has been widely observed, these countries tend to be small and affluent. This paper documents another robust empirical regularity: better-governed countries are much more likely than others to become tax havens. Controlling for other relevant factors, governance quality has a statistically significant and quantitatively large association with the probability of being a tax haven. For a typical country with a population under one million, the likelihood of a becoming a tax haven rises from 26% to 61% as governance quality improves from the level of Brazil to that of Portugal. Evidence from US firms suggests that low tax rates offer much more powerful inducements to foreign investment in well-governed countries than do low tax rates elsewhere. This may explain why poorly-governed countries do not generally attempt to become tax havens, and suggests that the range of sensible tax policy options is constrained by the quality of governance. Author Affiliation: (a) Department of Economics, University of Connecticut, 341 Mansfield Rd., U-1063, Storrs, CT 06269-1063, United States (b) Department of Economics, University of Michigan, 343 Lorch Hall, 611 Tappan Street, Ann Arbor, MI 48109-1220, United States Article History: Received 18 November 2008; Revised 20 May 2009; Accepted 8 July 2009 Article Note: (footnote) [star] We thank the Editor (Amy Finkelstein), three anonymous referees, Alan Auerbach, Charles Brown, Mihir Desai, Daniel Feenberg, Ray Fisman, Fritz Foley, James Sallee, Joel Slemrod, Jeff Smith, Stanley Winer, and various seminar and conference participants for helpful comments on earlier drafts. We also thank Mary Ceccanese for assistance with the OTPR data, and Sebastien Bradley and Owen Kearney for excellent research assistance.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2009.06.003 Byline: Alan Krause Keywords: Income taxation; Learning-by-doing; Commitment Abstract: This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of first-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates generally no longer apply. In particular, if the government cannot commit and each consumer's skill-type is revealed, it is optimal to distort the high-skill type's labour supply downwards through a positive marginal tax rate to relax an incentive-compatibility constraint. Our analysis therefore identifies a setting in which a positive marginal tax rate on the highest-skill individual can be justified, despite its depressing effect on both labour supply and wages. Author Affiliation: Department of Economics and Related Studies, University of York, Heslington, York, YO10 5DD, UK Article History: Received 12 June 2008; Revised 3 June 2009; Accepted 15 June 2009 Article Note: (footnote) [star] I am thankful for the helpful comments and suggestions of seminar participants at the Universities of Exeter and York, and at the 2008 FEMES-SAMES meeting of the Econometric Society and the 2009 meeting of the Canadian Economics Association. I also thank Craig Brett for a very helpful discussion regarding dynamic income taxation, and two referees for detailed and insightful comments that led to a much improved paper. Any remaining errors are my responsibility.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.regsciurbeco.2009.04.001 Byline: Thomas Eichner (a), Marco Runkel (b) Keywords: Separate accounting; Formula apportionment; Unemployment Abstract: Within a two-country model with involuntary unemployment, this paper investigates corporate income taxation under separate accounting versus formula apportionment. In contrast to separate accounting, under formula apportionment the corporate tax policy causes a fiscal externality that results from unemployment. This externality is the highest when the apportionment formula contains the payroll factor only. It is minimized for the pure sales (property) formula, if the substitution elasticity is low (high). The unemployment externality tends to compensate other externalities such that tax rates become inefficiently low. The deviation from the efficient tax policy is minimized when the apportionment formula contains the sales factor only. Author Affiliation: (a) Department of Economics, University of Bielefeld, Post Box 10 01 31, 33501 Bielefeld, Germany (b) Faculty of Economics and Management, University of Magdeburg, Postbox 4120, 39016 Magdeburg, Germany Article History: Received 23 October 2007; Revised 31 March 2009; Accepted 3 April 2009

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2009.03.002 Byline: Simone Moriconi (a)(b), Yasuhiro Sato (c) Keywords: Commodity taxation; Destination principle; Origin principle; Unemployment; Employment externality Abstract: In this paper, we evaluate the impact of commodity tax competition on welfare and employment under the destination and origin principles, when the labor market is imperfectly competitive owing to a binding fixed wage. Our main finding is that commodity taxation causes an employment externality whose signs may be opposite under the two principles. While tax competition leads to inefficient tax rates under both principles, we also prove that the origin principle guarantees lower unemployment and higher welfare when the fixed wage is high. Finally, we show that the employment externality still exists in a standard union model of wage determination. Author Affiliation: (a) SEMeQ, Universita del Piemonte Orientale, Via Perrone 18, 28100, Novara, Italy (b) CEP, London School of Economics, Houghton Street, London, WC2A 2AE, UK (c) Graduate School of Economics, Osaka University, 1-7, Machikaneyama, Toyonaka 560-0043, Japan Article History: Received 4 October 2006; Revised 15 December 2008; Accepted 20 March 2009

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.regsciurbeco.2009.01.005 Byline: Raymond G. Batina Keywords: Tax competition; Overlapping generations; Welfare effects Abstract: We extend the classic capital tax competition model to an overlapping generations economy and study the effects of a coordinated reform where capital tax rates across all locations are increased to alleviate the policy externality. Welfare across generations is examined and several new effects are derived. Simulations calibrated to US data indicate these effects may be as large as the spending effect of the classic model. The initial old generation, however, may not be better off, and an additional transfer from the initial young to the initial old may be required for the reform to be a Pareto improvement. Author Affiliation: School of Economic Sciences, Washington State University, Pullman, WA 99164, USA Article History: Received 14 April 2008; Revised 26 November 2008; Accepted 30 January 2009 Article Note: (footnote) [star] The author is indebted to Toshihiro Ihori, Mark Gibson, and the members of the Public Finance Workshop at WSU for their helpful comments on an earlier draft. We are also indebted to two helpful reviewers and the editor for their comments. Of course, the usual disclaimer applies.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.regsciurbeco.2009.01.008 Byline: Kristian Behrens (a)(b)(c), Jonathan H. Hamilton (d), Gianmarco I.P. Ottaviano (e)(f)(g), Jacques-Francois Thisse (g)(h) Keywords: Commodity tax competition; Origin principle; Destination principle; Tax harmonization; Industry location Abstract: We extend the model by Behrens et al. [Behrens, K., Hamilton, J.H., Ottaviano, G.I.P., Thisse, J.-F., 2007a. Commodity tax harmonization and the location of industry. Journal of International Economics 72, 271-291.] to the case of non-cooperative commodity taxation and investigate the impacts of tax harmonization and changes in tax principle on equilibrium tax rates, industry location, and welfare. Since our setup features internationally mobile firms, trade frictions, and asymmetric country sizes, it offers a convenient framework within which to investigate how differences in market size and deepening international integration affect equilibrium outcomes under competing tax principles. The origin principle, when compared to the destination principle, is shown to exacerbate tax competition and to erode tax revenues, yet gives rise to a more equal spatial distribution of economic activity. This suggests that federations which care about spatial inequality, like the European Union, face a non-trivial choice for their tax principle that goes beyond the standard considerations of tax revenue distribution. Author Affiliation: (a) Departement de Sciences Economiques, Universite du Quebec a Montreal, Canada (b) CIRPEE, Canada (c) CORE, Universite catholique de Louvain, Belgium (d) Department of Economics, University of Florida, USA (e) Faculty of Economics, Bocconi University Milan, Italy (f) FEEM, Italy (g) CEPR, United Kingdom (h) PSE, France Article History: Received 23 October 2008; Revised 20 December 2008; Accepted 7 January 2009 Article Note: (footnote) [star] This paper is dedicated to Masahisa Fujita for his 65th birthday.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2009.02.011 Byline: Mihir A. Desai (a), Dhammika Dharmapala (b) Keywords: Foreign portfolio investment; Foreign direct investment; Taxes; Investor protections Abstract: Investors can access foreign diversification opportunities through either foreign portfolio investment (FPI) or foreign direct investment (FDI). The worldwide tax regime employed by the US potentially distorts this choice by penalizing FDI, relative to FPI, in low-tax countries. On the other hand, weak investor protections in foreign countries may increase the value of control, creating an incentive to use FDI rather than FPI. By combining data on US outbound FPI and FDI, this paper analyzes whether the composition of US outbound capital flows reflects these incentives to bypass home and host country institutional regimes. The results suggest that the residual tax on US multinational firms' foreign earnings skews the composition of outbound capital flows -- a 10% decrease in a foreign country's corporate tax rate increases US investors' equity FPI holdings by approximately 10%, controlling for effects on FDI. Investor protections also seem to shape portfolio choices, though these results are not robust when only within-country variation is employed. Author Affiliation: (a) Harvard University and NBER, United States (b) University of Connecticut, United States Article History: Received 16 December 2007; Revised 22 February 2009; Accepted 25 February 2009

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2008.09.010 Byline: Lorenzo Forni, Libero Monteforte, Luca Sessa Keywords: Fiscal policy; Distortionary taxation; DSGE modeling; Bayesian estimation Abstract: This paper describes a dynamic stochastic general equilibrium model featuring a fraction of non-Ricardian agents in order to estimate the effects of fiscal policy in the Euro area. The model takes into account distortionary taxation on labor and capital income and on consumption, while expenditures are broken down into purchases of goods and services, compensation of public employees and transfers to households. A newly computed quarterly data set of fiscal variables is used. Our results point to the prevalence of mild Keynesian effects of public expenditures. In particular, although innovations in fiscal policy variables tend to be rather persistent, government purchases of goods and services and compensations for public employees have small and short-lived expansionary effects on private consumption, while innovations in transfers to households show a slightly more sizeable and lasting effect. The effects are more significant on the revenue side: decreases in labor income and consumption tax rates have sizeable effects on consumption and output, while a reduction in capital income tax favors investment and output in the medium run. Finally our estimates suggest that fiscal policy variables contribute little to the cyclical variability of the main macro variables. Author Affiliation: Banca d'Italia, Economic outlook and monetary policy department, Italy Article History: Received 18 October 2007; Revised 19 September 2008; Accepted 24 September 2008 Article Note: (footnote) [star] We benefited from comments by Alberto Alesina, Silvia Ardagna, Susanto Basu, Paul Cahu, Fabio Canova, Marco Del Negro, Rochelle Edge, Nicola Fuchs-Schundeln, Francesco Furlanetto, Jordi Gali, Teresa Garcia-Mila, Peter Ireland, Paolo Manasse, Greg Mankiw, Domenico Marchetti, Roberto Perotti, Pedro Teles and seminar participants at Banca d'Italia, Bocconi, Bologna, Harvard and P. Fabra, and at CEF, Dynare, EEA, Moncasca and SED annual meetings, Macroeconomic Modeling Central Bank Workshop in Santiago de Chile, and Fiscal Stabilization Policies in a Monetary Union Conference at DG-Ecfin in Brussels. We would like to thank three anonymous referees for their advices, which have significantly improved the paper, and the members of the Banca d'Italia DSGE working group for their support, in particular Andrea Gerali, Claudia Miani, Stefano Neri and Massimiliano Pisani. The views expressed in this paper are those of the authors and do not involve the Bank of Italy.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jpubeco.2008.09.008 Byline: Neslihan Uler Keywords: Public goods; Charitable giving; Redistributive taxation; Efficient private provision Abstract: This paper studies the relationship between redistributive taxation and tax-deductible charitable contributions. Redistribution has two opposite effects on voluntary giving. The price of charitable giving decreases with the degree of redistribution, and this has a positive effect on the total amount of giving (substitution effect). However, redistribution leads to lower consumption for the contributors and therefore has a negative effect on contributions to the charity (income effect). The theoretical model developed in this paper demonstrates that, under a general class of utility functions, the substitution effect dominates the income effect. Hence, charitable giving increases with the tax rate. In purely egalitarian societies, the public good is provided efficiently and the total welfare is maximized independent of the ex-ante income inequality. However, the positive impact of taxation on charitable giving and welfare may disappear if individuals generate their income levels in anticipation of taxation and redistribution does not take into account the cost of effort. Author Affiliation: Research Center for Group Dynamics, ISR, Michigan University, USA Article History: Received 3 May 2006; Revised 21 February 2008; Accepted 17 September 2008 Article Note: (footnote) [star] I am grateful to Debraj Ray, Andrew Schotter, Alessandro Lizzeri, and William Easterly for their constant support throughout the project. I also thank Pinar Derin, Joan Esteban, Kfir Eliaz, Kyle Hyndman, Yusufcan Masatlioglu, Efe Ok, Jean-Benoit G. Rousseau, Doug Smith, two anonymous referees, seminar participants in the 17th International Conference on Game Theory, Economic Science Association 2006 meetings, New York University, Michigan State University and Cleveland State University for helpful comments.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.joep.2008.09.002 Byline: Louis Levy-Garboua (a), David Masclet (b), Claude Montmarquette (c) Keywords: Taxation and labor supply; Laffer curve; Experimental economics; Fairness and efficiency; Social norms and sanctions; Informational asymmetry; Emotions Abstract: This paper demonstrates, through a controlled experiment, that the 'Laffer curve' phenomenon does not always reflect a conventional income - leisure trade-off. Whether out of reason or out of emotion, taxpayers may also be willing to punish intentionally unfair tax setters by working less than they would under the same exogenous circumstances. We conduct a real effort experiment in which a player A (the 'tax receiver') is matched with a player B (the 'worker') to elicit the conditions under which tax revenues will increase under a certain threshold and decrease thereafter. We ran four different treatments by manipulating work opportunities and the power to tax. Consistent with the history of tax revolts, the working partner overreacts to the perceived unfairness of taxation when the tax rate exceeds 50%, most strongly so in the high effort treatment. With two types of players, selfish and empathic, our model predicts the emergence of a social norm of fairness under asymmetric information, and elicits the optimal and emotional patterns of punishments and rewards consistent with the norm's enforcement. The social norm allows players to coordinate tacitly on a 'focal equilibrium', which offers a solution to the indeterminacy raised by the Folk theorem for infinitely-repeated games and a behavioral justification for the tit-for-tat strategy. The social norm of fairness enhances productive efficiency in the long run. Author Affiliation: (a) Universite Paris I, Centre d'economie de la Sorbonne, Paris School of Economics and CIRANO, 106-112, boulevard de l'HA[acute accent]pital, 75013 Paris, France (b) CREM (Center for Research in Economics and Management), Universite Rennes I and CIRANO, 7 place Hoche, 35065 Rennes (c) Universite de Montreal and CIRANO, 2020, rue University, 25e, Montreal, Quebec, Canada H3A 2A5 Article History: Received 17 September 2007; Revised 29 August 2008; Accepted 17 September 2008

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jdeveco.2008.03.001 Byline: Stephen J. Turnovsky (a), Md.A. Basher (b) Keywords: Formal and informal sectors; Labor mobility; Fiscal policy; Auditing Abstract: This paper develops a two-sector model of a developing economy and examines the role of the informal sector in limiting the government's ability to increase tax revenues. A key feature is the introduction of auditing of the informal sector and degree of tax enforcement in that sector. We emphasize the interdependence between tax policy and enforcement in achieving a developing economy's fiscal objectives and show that by judicious policy choices the presence of the informal sector need not hinder its ability to raise tax revenues. We supplement the formal analysis with numerical simulations highlighting the contrasting intertemporal tradeoffs implied by higher tax rates and tax-enforcement levels. Author Affiliation: (a) University of Washington, Seattle, WA, 98195, United States (b) Willamette University, Salem, OR, 97301, United States Article History: Received 17 January 2007; Revised 28 February 2008; Accepted 11 March 2008 Article Note: (footnote) [star] This paper is an extensively revised version of Chapter 1 of Basher's thesis written at the University of Washington. We wish to thank two anonymous referees and the Editor, Lant Pritchett, for their constructive suggestions. Turnovsky's research was supported in part by the Castor endowment at the University of Washington.