Capital Controls as Taxation Policy

This paper studies the public finance implications of controls on international financial capital flows, proposing a model of controls as distortionary taxation. The model formalizes a capital controls rule that conforms real-world stylized facts and is sustainable in the long-run. Capital controls are shown to distort agents' optimal intratemporal portfolio decisions and intertemporal consumption decisions, affecting the dynamics of financial and real variables. We use the model to analyze the feasible set of tax instruments - in terms of level and mix -available to the government and the complex relationships between expenditures and taxes mediated by the foreign sector.