Taxing foreign capital in Brazil: a sequential game

Emerging market economies have witnessed a surge in capital inflows as a result of monetary expansion in developed countries in the aftermath of the 2008 crisis. In this paper, we have modeled the Brazilian decision to tax foreign capital inflows, which were deemed to hurt country’s firm’s competitiveness as they made the Real currency stronger. We have presented a game between three players in which each agent maximizes its utility function in a sequential framework. The main result is that with everything else held constant the Brazilian government’s decision to tax foreign capital leads to an increase in domestic interest rates. Cost of capital should raise as a consequence of the strategic behavior of involved actors, namely the government, domestic banks and foreign investors. A cautious approach on those measures is then warranted.