General equilibrium effects of investment incentives in Mexico

Mexico has experimented with several tax instruments designed to promote private capital formation. Among such initiatives were general and industry-specific tax credits, employment tax credits, and corporate tax credits. The authors examine relative efficacy of such instruments using a dynamic computable general equilibrium model. They carry out model simulations using three equal-yield investment incentive scenarios: increases in investment tax credits, increases in employment tax credits, and an equivalent reduction in the corporate tax rate. The authors present outlines of the tax policy environment with model details and they highlight alternate tax incentives regimes. Conclusions and summary results are provided by the authors.International Terrorism&Counterterrorism,Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,Public Sector Economics&Finance

Tax policy options to promote private capital formation in Pakistan

The authors developed a simple two-period general equilibrium model to analyze the macroeconomic impact of tax policies in Pakistan. They analyze two scenarios. In scenario 1, the investment tax credit rate is increased from 15 percent to 30 percent. The new fiscal regime increases investment but also significantly increases inflation. In scenario 2, the original investment tax credit rate is retained but the statutory corporate tax rate is reduced. Welfare improves more than under scenario 1. The authors conclude that in Pakistan, at least, changes in corporate tax rates are probably better instruments for promoting capital formation than are increased investment tax credits. In particular, cuts in corporate taxes improve welfare more than do increases in investment tax credits. Increasing the investment tax credit stimulates more capital formation than does decreasing corporate taxes, but the tax credits also have significant macroeconomic consequences.Environmental Economics&Policies,Public Sector Economics&Finance,Banks&Banking Reform,International Terrorism&Counterterrorism,Economic Theory&Research

Fiscal stabilization and exchange rate instability

The aim of this paper is to examine the implications for certain key macroeconomic variables in relation to reductions in public spending. In particular, the paper looks at; the rate of inflation, the interest rate, and the rate of growth of real GNP. The paper develops an intertemporal general equilibrium model that is used to analyze reductions in government spending and the implications for the exchange rate and the balance of payments of these reductions. Section II gives a brief review of background literature and provides an intuitive explanation of our model. Section III formally derives the analytics of the model, while Section IV sketches a proof of the existence of an intertemporal equilibrium. Section V gives some policy simulations using Mexican data, and finally, Section VI concludes the paper.Economic Stabilization,Banks&Banking Reform,Public Sector Economics&Finance,Economic Theory&Research,Environmental Economics&Policies

International versus Domestic Auditing of Bank Solvency

This paper examines alternative ways to prevent losses from bank insolvencies. It is widely viewed that transparency in reporting bank balance sheets is a key element in reducing such losses. It is, however, unclear just how such transparency would be achieved. Current approaches to avoiding insolvencies generally involve international enforcement mechanisms. Among these are the sovereign debt restructuring mechanism (SDRM), and, more generally, an international bankruptcy court. We develop a model that compares two alternative institutions for bank auditing. Neither of these institutions would require as much enforcement capability as an international bankruptcy court, hence they would be easier to introduce. The first of these is a system of central bank auditing of national banks. The second type of auditing is carried out by an international agency that collects risk information on banks in all countries and then provides it to depositors. Using a game-theoretic approach, we compare the informativeness of the disclosure rule in the symmetric Perfect Bayesian equilibrium in each of the two di.erent auditing institutions. We show that the international auditor generally performs at least as well, and sometimes better than, auditing by either central banks, which, in turn, perform better than voluntary disclosure by the banks themselves. The results do not assume any informational advantages of the international auditor, nor is the international auditor somehow less "corrupt" than the central banks. Rather, the international auditor's credibility comes from the simple fact that its incentives are not distorted by a sovereignty bias that plagues the central banks.Bank Insolvency, Auditing, International Auditing.

An analysis of repressed inflation in three transitional economies

In centrally planned economies, domestic prices do not respond flexibly to market forces, so economic disequilibria - including repressed inflation - persist. The authors assess the extent of repressed inflation in Czechoslovakia, Poland, and Romania between 1980 and 1990. First, they develop a simultaneous equation model, which stipulates that the repressed inflation is caused by the difference in growth rate between households'money holdings and retail sales in the economy. Following are the model's basic assumptions: a stable demand for money function exists where the demand for real quasi-money depends on the level of real income and the expected rate of inflation; inflationary expectations are formed under an adaptive scheme in which expected inflation for the next period depends on the error made in predicting the current period's true inflation; the real stock of quasi-money balances adjusts to the desired level, after a time lag. The authors then derive a reduced-form equation on real quasi-money holdings, and estimate it with quarterly data for Czechoslovakia and Poland, and with annual data for Romania. Based on the estimated equation, they derive the true inflation rate for each economy. Finally, they determine the significance of the repressed inflation in each economy through statistical tests on parameters of the estimated equation. These are the authors'main findings: during 1980-90 in Czechoslovakia, repressed inflation was insignificant, the demand for money was mostly for transaction purposes, and inflationary expectations were almost myopic; in Poland, repressed inflation was significant but decreasing after 1987, and inflationary expectations adjusted fairly rapidly; and in Romania, repressed inflation was serious throughout the period, and inflationary expectations adjusted quite rapidly. This economic model needs to be refined and the data used need to be improved. But the paper's findings are broadly consistent with the results of most other studies.Economic Theory&Research,Markets and Market Access,Access to Markets,Environmental Economics&Policies,Banks&Banking Reform

International versus Domestic Auditing of Bank Solvency

This paper examines alternative ways to prevent losses from bank insolvencies. It is widely viewed that transparency in reporting bank balance sheets is a key element in reducing such losses. It is, however, unclear just how such transparency would be achieved. Current approaches to avoiding insolvencies generally involve international enforcement mechanisms. Among these are the sovereign debt restructuring mechanism (SDRM), and, more generally, an international bankruptcy court. We develop a model that compares two alternative institutions for bank auditing. Neither of these institutions would require as much enforcement capability as an international bankruptcy court, hence they would be easier to introduce. The first of these is a system of central bank auditing of national banks. The second type of auditing is carried out by an international agency that collects risk information on banks in all countries and then provides it to depositors. Using a game- theoretic approach, we compare the informativeness of the disclosure rule in the symmetric Perfect Bayesian equilibrium in each of the two different auditing institutions. We show that the international auditor generally performs at least as well, and sometimes better than, auditing by either central banks, which, in turn, perform better than voluntary disclosure by the banks themselves. The results do not assume any informational advantages of the international auditor, nor is the international auditor somehow less "corrupt" than the central banks. Rather, the international auditor's credibility comes from the simple fact that its incentives are not distorted by a sovereignty bias that plagues the central banks.Bank Insolvency, Auditing, International Auditing.

"Big Bang" Versus Gradualism in Economic Reforms: An Intertemporal Analysis with an Application to China

This paper analyzes issues concerning the speed of adjustment and sequencing of reforms in a transition economy. It presents a dynamic general equilibrium model parameterized with Chinese data. The model is used to generate different policy simulations that highlight the importance of the policy instruments used during the transition period. The simulations consider privatization, tariff reform, and devaluation, as well as alternative speeds of introducing these policies. They show that different speeds of adjustment, as well as sequencing of reforms, will have very different implications for macroeconomic aggregates. Copyright 2003, International Monetary Fund

Tax Evasion, the Provision of Public Infrastructure, and Growth: A General Equilibrium Approach to Two Very Different Countries, Egypt and Mauritius

We construct a dynamic multi-period general equilibrium model and use it to analyze prospects for growth in two very different countries, Egypt and Mauritius. The use of a single model has the advantage that when comparing alternative policies across countries, it is not necessary to worry if different conclusions are based solely upon model differences, as would be the case with multiple models. In the case of Egypt we look at the effects of the revolution of 2011 on growth, in particular, at the impact of a dramatic decline in tourism. In addressing the issue of how to increase growth we focus upon a particular problem in Egypt, namely the low rate of tax compliance. Accordingly, we look at fiscal policies designed to reduce tax evasion, and find that these policies are also successful in modestly increasing GDP growth. Mauritius has not suffered from any immediate shock, as has Egypt. However shortages in public infrastructure have been identified as bottlenecks in GDP growth, which has slowed in recent years. We therefore estimate elasticities of private production with respect to stocks of public infrastructure, and use these elasticities to implement our general equilibrium model. We find that modest increases in spending upon public infrastructure, compensated for by corresponding decreases in current spending, can lead to increases in real GDP growth. Beyond certain levels, however, more infrastructure spending will actually lead to a decline in real GDP growth

A Computational General Equilibrium Approach to Sectoral Analysis for Tax Potential: An Application to Pakistan

This study develops a dynamic general equilibrium model, applied to Pakistani data, in which optimizing agents evade taxes by operating in the underground economy. The cost to firms of evading taxes is that they find themselves subject to credit rationing from banks. Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base. Aggregate investment in the economy is lowered because of credit rationing. Taxes that are too low eliminate the underground economy, but result in unsustainable budget and trade deficits. Thus, the optimal rate of taxation, from a macroeconomic point of view, may lead to some underground activity. We note, in particular, that incorporating a VAT without any other tax reductions greatly reduces the tax compliance of the service sector. We have applied our model to Pakistan, and have calibrated our model to an 8 year period from 2004-2011. We note that it gives a reasonable approximation of Pakistani macro data. We then use a sectoral breakdown of tax data generated by the model to estimate tax gaps on a sector by sector basis. We note that certain sectors are currently paying taxes below their potential, while others may be above their tax potential. These sectoral gap estimates may be used as indicators of where greater tax enforcement efforts should be directed