Department of Economics

TAX EFFECTS ON THE REAL EXCHANGE RATE

Department of Economics

University of Delaware

Working Paper #2003-11

TAX EFFECTS ON THE REAL EXCHANGE RATE

Stacie Beck and Cagay Coskuner

ABSTRACT

This study examines the effects of taxes on the real exchange rate through their marginal impacts on economic activity. We develop a model that shows that an increase in the capital interest tax rate leads to real domestic currency depreciation while an increase in wage or consumption tax rates lead to a real domestic currency appreciation. These theoretical findings are supported by an empirical study using panel data estimations of ten OECD countries over 17 years.

JEL classification: C23, F31, F41, H30.

Keywords: Fiscal Policy, Distortionary Taxation, Real Exchange Rates.

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