An Equilibrium Analysis of International Fiscal Transfers as Insurance against Asymmetric Shocks

A static two-country general equilibrium model with uncertainty about labor productivity is developed to analyze potential welfare gains from fiscal cooperation under ex-ante heterogeneity of agents. The fiscal transfer scheme under consideration is a flat uniform labor income tax redistributed as equal lump-sum transfers. Simulations of the bargaining solution show that fiscal cooperation generally reduces output and employment, but can be desingned to provide Pareto improvements on the competitive market equilibrium through interpersonal riskpooling.