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Titill

Estimating the Effects of a Tax Reform in a Small Open Economy

Leiðbeinandi
Útdráttur

The effects of reforming the Icelandic tax system are studied with a simple dynamic
general equilibrium model. With the revision, taxes on consumption, labour income
and capital gains were raised, all of which are distortionary forms of taxation. The
model used for the analysis is therefore designed to focus on taxation and it’s effect on
the behaviour of economic agents. In addition, the model incorporates adjustment
costs to investment, which creates an incentive for the household sector to spread
investment over time.
The optimal tax rates are derived to serve as a benchmark when the effects of the
tax reform are examined. The model is solved for the three regimes, that is, the
optimal tax regime, which is based on lump-sum taxes, the before tax reform regime
and the new, more distorting regime. It is found that the tax reform will generate a
welfare loss of approximately eight percent, where the loss is defined as the additional
consumption required to render the households indifferent between the new and old
regimes.
Finally, it is explored how sensitive the results are to changes in the values of some
of the exogenous parameters. The results are found to be relatively insensitive to
changes in the time discount factor and adjustment cost parameter, but are more
responsive to variation in the elasticity of intertemporal substitution.

Birting
12.5.2010


Skrár
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