Confronting increases to labour and capital taxes to finance the pension deficit in the Dominican Republic: a real business cycle approach

Ageing demographics have prompted widespread pension reforms across Latin America. This has left several countries with a significant financial burden related to the transition from one system to another. In this article, we evaluate two alternative methods of financing the recent pension reform in the Dominican Republic. We build on a simple real business cycle model with perfect competition and add a fiscal block that allows us to simulate shocks to the tax rates on capital and labour, based on the present value of the pension reform cost. We find that increasing the tax rate on returns to capital would not only fill the pension deficit, but also have a significantly smaller adverse effect on the macroeconomy, when compared with an increase to the tax on labour.