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On Dynamic Tax Reform with Regime Switching

Fu-Jen Catholic University, Taiwan

Hsueh-fang Tsai

Fu-Jen Catholic University, Taiwan

This article investigates the effect of tax reform from the viewpoint of regime switching and finds that, following a tax-reform announcement with constant government spending, the key factor determining the adjustment patterns of consumption and capital is the relative extent of the tax-reform-induced "substitution effect" versus the tax-reform-induced "savings-investment effect." Furthermore, if a rise in government spending is associated with an announcement of tax-financing change, then a crowding-in, a partial crowding-out, or an over-crowding-out effect may be exhibited prior to a government financing change. At the instant of regime switching, consumption exhibits a discontinuous fall to ensure the optimality condition.

Key Words: tax reform • income taxation • consumption taxation • regime switching • investment

Public Finance Review, Vol. 34, No. 3, 306-327 (2006)
DOI: 10.1177/1091142105284914


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