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Nonlinear Capital Flow Tax: Capital Flow Management and Financial Crisis Prevention in China
2019-07-20 08:43:00

China & World Economy / 1–28, Vol. 27, No. 4, 2019


Nonlinear Capital Flow Tax: Capital Flow Management
and Financial Crisis Prevention in China
Jiandong Ju, Li Li, Guangyu Nie, Kang Shi, Shang-Jin Wei


Abstract

How to promote capital account liberalization while preventing financial crises is a challenging task for policymakers. This study proposes a nonlinear (progressive) capital flow tax as a solution. We first demonstrate that the collateral requirement of international borrowing can give rise to multiple equilibria and self-fulfilling financial crises. We then show that the crisis equilibrium characterized by large exchange rate depreciation, capital flight and welfare loss can be eliminated by imposing a nonlinear (progressive) tax scheme on capital outflows with the marginal tax rate increasing with the size of individual capital outflows. The implementation of such a tax scheme in China is also discussed.


Key words: capital account openness, financial crisis, nonlinear capital flow tax
JEL codes: F34, F41, H21