Investment-Promoting Policies in the Presence of International Interactions

Investment-promoting policies in a small open economy are analyzed by means of a dynamic applied general equilibrium model with overlapping generations. Simulations of a decrease of the corporate income tax rate and an increase of the investment tax credit rate are discussed and compared. This paper examines in particular the extent to which international trade and capital flows interfere in both tax policies. The modeling of overlapping generations allows moreover to identify the winners and losers of these reforms. It is shown that the subsidy policy is preferred to the profit tax policy when a small open economy seeks to stimulate capital formation.