ELIMINATING INTEREST TAXATION AND TARIFFS - THE UNDERPINNINGS FOR RECENT CANADIAN POLICY

Blanchard's (1985) formulation of the overlapping-generations model and the social welfare function advocated by Calvo and Obstfeld (1988) are used to analyse interest taxation and tariffs in a small open economy. When the revenue lost from the elimination of these taxes is replaced by raising the tax on labour, as in recent Canadian experience, a 'low' social discount rate is required for the model to support lower interest-income taxes, while a 'high' discount rate is needed to support the elimination of tariffs. We illustrate the empirical importance of this simultaneous need for both a 'high' and a 'low' discount rate.