Capital depreciation allowances,redistributive taxation,and economic growth

Are capital depreciation allowances when coupled with capital income taxes good instruments for redistribution in the long run? In a simple two-agent-economy I find that accelerated depreciation is good for growth, but bad for redistribution. The opposite holds for capital income taxes. However, in a feedback Stackelberg equilibrium, where the government is the leader and the private sector the follower, the depreciation allowance is maximal in the long run, time-consistent optimum. This removes the accumulation distortion of capital income taxes. Furthermore, the latter, and so redistribution, is found to be generically nonzero in the time-consistent optimum, and depends on the social weight of transfers receivers, the pretax factor income distribution, the intertemporal elasticity of substitution and the time preference rate. Thus, accelerated depreciation allowances are an important indirect tool for redistribution. The tax scheme allows for a separation of “efficiency” and “equity” concerns for redistributive policies.     

Yet another long-run neutrality result: Absence of tax-induced growth effects under implicit intergenerational contracts

We provide an example whereby the existence of optimal time-consistent implicit contracts between the young parent and the yet-to-be-born child could nullify the long-run effects of income taxes on human-capital investment and growth. Implications for the Ricardian equivalence theorem are also discussed.     

Reexamining the interaction between innovation and capital accumulation

In endogenous growth models with innovation and capital accumulation Arnold [J. Macroeconomics 20 (1998) 189] and Blackburn et al. [J. Macroeconomics 22 (2000) 81] show that long-run growth of per capita income is independent of innovation activities; it is solely determined by preferences and the human capital accumulation technology. As a result, government policies do not affect long-run growth. This paper develops an endogenous growth model with innovation and (physical and human) capital accumulation to show that long-run growth depends on both innovation and capital accumulation technologies as well as on preferences and that government taxes and subsidies can have effects on the long-run growth rate.     

Do Distortionary Taxes Always Harm Growth?

This paper examines the long-run effects of capital income taxes, labor income taxes, and expenditure taxes in an R&D-based model of endogenous growth with endogenous labor supply. The main contribution of this paper is to investigate how tax effects on long-run growth are influenced by the emergence of indeterminate equilibria. Indeterminacy in this instance arises due to nonseparable preferences between consumption and leisure, in conjunction with prior distortionary taxes. In contrast to conventional wisdom, we show that higher distortionary taxes improve long-run growth, as well as social welfare, when the steady state is indeterminate.     

Simple Rules for the Optimal Taxation of International Capital Income

In this paper we reconcile and extend previous results on the collectively optimal taxation of international investment income. The “weighted average” rule of Horst (1980), for example, is shown to rest on unattractive assumptions on the set of instruments available, ruling out any need for distorting taxes. The principal contribution is to establish a new and strikingly simple weighted average rule — encompassing the other key result in this area — for the general case in which lump-sum taxes are unavailable, the ability to tax pure profits is perhaps restricted and distorting taxes on both domestic and border-crossing capital income are optimally deployed.     

Macroeconomic impacts of fiscal policy shocks in the UK: A DSGE analysis

This paper develops and estimates a new-Keynesian dynamic stochastic general equilibrium (DSGE) model for the analysis of fiscal policy in the UK. We find that government consumption and investment yield the highest GDP multipliers in the short-run, whereas capital income tax and public investment have dominating effect on GDP in the long-run. When nominal interest rate is at the zero lower bound, consumption taxes and public consumption and investment are found to be the most effective fiscal instruments throughout the analysed horizon, and capital and labour income taxes are established to be the least effective. The paper also shows that the effectiveness of fiscal policy decreases in a small open-economy scenario and that nominal rigidities improve effectiveness of public spending and consumption taxes, whereas decrease that of income taxes.     

The engine of growth or its handmaiden?

This paper presents an analysis of time-series data for the countries in the Summers-Heston (1991) data set, in an attempt to ascertain the evidence for or against the export-led growth hypothesis. We find that standard methods of detecting export-led growth using Granger-causality tests may give misleading results if imports are not included in the system being analyzed. For this reason, our main statistical tool is the measure of conditional linear feedback developed by Geweke (1984), which allows us to examine the relationship between export growth and income growth while controlling for the growth of imports. These measures have two additional features which make them attractive for our work. First, they go beyond meredetection of evidence for export-led growth, to provide a measurement of itsstrength. Second, they enable us to determine the temporal pattern of the response of income to exports. In some cases export-led growth is a long-run phenomenon, in the sense that export promotion strategies adopted today have their strongest effect after eight to 16 years. In other cases the opposite is true; exports have their greatest influence in the short run (less than four years). We find modest support for the export-led growth hypothesis, if “support” is taken to mean a unidirectional causal ordering. Conditional on import growth, we find a causal ordering from export growth to income growth in 30 of the 126 countries analyzed; 25 have the reverse ordering. Using a weaker notion of “support”—stronger conditional feedback from exports to income than vice versa, 65 of the 126 countries support the export-led growth hypothesis, although the difference in strength is small. Finally, we find that for the “Asian Tiger” countries of the Pacific Rim, the relationship between export growth and output growth becomes clearer when conditioned on human capital and investment growth as well as import growth.     

Unions, progressive taxes, and education subsidies

Progressive income taxes moderate distortionary wage demands by trade unions and thereby reduce unemployment, and at the same time underlie disincentives to acquire skills and decrease labour productivity. Governments can respond by combining progressive taxes with subsidies to investment in human capital. A system of generous education subsidies and steep progressive tax rates is more likely to emerge, the greater the market power of trade unions and the better the ability of governments to influence private education decisions. Empirical analysis for several OECD countries provides results consistent with these propositions. A policy mix of high education subsidies and relatively progressive income taxes is found in countries where union membership is significant.     

Is Social Security Really Bad for Growth?

This paper develops a model of endogenous growth with overlapping generations to investigate the joint determination of social security, public investment, and growth in a small open economy. We show that a pure pay-as-you-go system with benefits indexed to wages provides taxpayers with incentives to support growth-oriented policies, which increase the future productivity of labor. We find that outcomes characterized by positive levels of intergenerational redistribution, public investment, and long-run growth can be sustained as subgame-perfect Nash equilibria of an infinitely repeated intergenerational game, if and only if the marginal productivity of public capital is large enough. Furthermore, we show that transfers comove with public investment and growth. Journal of Economic Literature Classification Numbers: E62, H55.     

Redistributive policy,inequality and growth

Does redistribution increase inequality? Is inequality harmful for growth? Both questions have recently been addressed in a number of single-tax models. In this paper, I examine the relationship between policy, growth and inequality when income and inherited wealth can be taxed at different rates. In the model, parents accumulate human capital and a return-bearing, storable good in order to increase the quality of their children. Inequality arises because the learning ability of children is stochastic. Redistributive labor income taxation has a negative impact on short- and long-run growth while taxation of inherited stocks increases growth. Effects of both taxes on income inequality are ambiguous. A switch from income to inheritance taxation may increase average utility of all generations involved. I calculate a structure-induced equilibrium of the political process by means of a stochastic simulation of the model. In the short run initial wealth-inequality can stimulate growth, while initial inequality of the endowment with human capital is harmful for growth.     

Time-consistent taxation in a dynastic family model with human and physical capital and a balanced government budget

Abstract .  This paper analyzes optimal, time consistent taxation in a dynastic family model with human and physical capital and with a balanced government budget. When tax revenue is used for publicly provided consumption or lump-sum transfers, leisure would be higher than its social optimum. Pareto optimal taxation requires taxing capital income more heavily than labour income and subsidizing investment at the same rate of the tax. Also, it requires either subsidizing labour at the same rate as a consumption tax or subsidizing consumption at the same rate as a labour income tax, and hence it is not a practical guide to policy. Further, a consumption tax, or equivalently a uniform income tax with investment subsidies at the same rate, can be improved on by taxing capital income more heavily than labour income.     

Rat race, redistribution, and growth

Introducing locally negatively interdependent preferences into a simple AK growth model easily explains the often observed insignificant or positive correlation between distortionary redistribution and growth rates. Positive capital income taxes and lump sum transfers are harmful for growth, but people rationally vote for them in order to reduce “rat race” overaccumulation. A “neutrality proposition” holds if the pivotal voter is the mean voter, as in a representative agent case, but it fails if the pivotal voter is poorer than the average citizen.     

Good Jobs,Bad Jobs and Redistribution*

We analyse the question of optimal taxation in a dual economy, when the policy‐maker is concerned about the distribution of labour income. Income inequality is caused by the presence of sunk capital investments, which creates a “good jobs” sector due to the capture of quasi‐rents by trade unions. With strong unions and high planner preference for income equality, the optimal policy is a combination of investment subsidies and progressive income taxation. If unions are weaker, the policy‐maker may instead choose to tax investment.     

Tax policy, venture capital, and entrepreneurship

The paper studies the effects of tax policy on venture capital activity. Entrepreneurs pursue a single high risk project each but have no own resources. Financiers provide funds, covering investment cost plus an upfront payment, in exchange for a share in the firm. The contract must include incentives to enlist full effort of entrepreneurs. Venture capitalists also assist with valuable business advice to enhance survival chances. The paper develops a general equilibrium framework with a traditional and an entrepreneurial sector and investigates the effects of taxes on the equilibrium level of managerial advice, entrepreneurship and welfare. It considers differential wage and capital income taxes, a comprehensive income tax, progressive taxation as well as investment and output subsidies to the entrepreneurial sector.     

Optimal fiscal policy in a model with inherited aspirations and habit formation

In this paper, we analyze optimal fiscal policies in an overlapping generations framework, where preferences exhibit aspirations in consumption and environmental quality as well as habit formation. We focus on the second best policies when the government needs to finance a given stream of public expenditures by using distortionary taxes. We derive necessary and sufficient conditions under which the competitive equilibrium is characterized by levels of capital and environmental quality that are too small and a level of labor supply that is too large. Our numerical simulations show that an optimal fiscal policy can be used as an effective stabilization device and that when consumption taxes are fixed, the planner implements maintenance investment and capital income subsidies while financing public spending through labor and fixed consumption taxes.     

Trade,environment, and income inequality: An optimal taxation approach

In a small open economy, how should a government pursuing both environmental and redistributive objectives design domestic taxes when redistribution is costly? And how does trade liberalization affect the economy's levels of pollution and inequalities, when taxes are optimally and endogenously adjusted? Using a general equilibrium model under asymmetric information with two goods, two factors (skilled and unskilled labor), and pollution, this paper characterizes the optimal mixed tax system (nonlinear income tax and linear commodity and production taxes/subsidies) with both production and consumption externalities. While optimal income taxes are not directly affected by environmental externalities, conditions are derived under which under‐ or over‐internalization of social marginal damage is optimal for redistributive considerations. Assuming that redistribution operates in favor of the unskilled workers and that the dirty sector is intensive in unskilled labor, simulations suggest that trade liberalization involves a clear trade‐off between the reduction of inequalities and the control of pollution when the source of externality is only production; this is not necessarily true with a consumption externality. Finally, an increase in the willingness to redistribute income toward the unskilled results paradoxically in less pollution and more income inequalities.     

Parental human capital investment and old-age transfers from children: Is it a loan contract or reciprocity for Indonesian families?

This paper proposes two alternative models of intergenerational transfers linking parental investment in human capital of children to old-age support. The first model formulates these transfers as a pure loan contract and the second model as self-enforcing reciprocity. Both models predict neutrality of intergenerational redistribution of resources within the family, also known as the “difference in income transfer derivatives property”. Two models, however, provide different reasons for the failure of this property, and yield different policy implications for parental human capital investment and provision of old-age support. Specification tests on the Indonesian Family Life Survey data reject the pure loan model in favor of the reciprocity model. The estimated difference in income transfer derivatives for this data is found to be significantly higher than the difference estimated by Altonji, Hayashi and Kotlikoff Altonji et al. (1992) [Altonji, J.G., Hayashi, F. and Kotlikoff, L.J. (1992). Is the Extended Family Altruistically Linked? Direct Tests Using Micro Data. The American Economic Review, vol. 82(5): 1177–98.] for the U.S. PSID data.     

The growth effects of tax rates in the OECD

This paper explores the merits of macro‐ and micro‐based tax rate measures within an open economy “fiscal policy and growth” model. Using annual data for 15 OECD countries we find statistically small, non‐robust long‐run growth effects of macro‐based average tax rates on capital income and consumption, but some evidence for average labour income tax effects. Changes in “micro” marginal income tax rates at both the personal and corporate levels yield statistically robust GDP responses of modest size. Both domestic and foreign corporate taxes appear relevant. In general, tax effects on GDP operate largely via factor productivity rather than factor accumulation.     

Endogenous growth cycles—Arrow's learning by doing reconsidered

A two-sector growth model is presented in which human capital is acquired through learning by doing. It is shown that, for both the competitive situation and the social optimum, endogenous growth cycles may be the outcome. Concerning the economic prerequisite for persistent oscillations we detect a bunching of investment at nearby dates leading economic variables to overshoot the long-run steady state values. This clustering of investment, for its part, may be caused by adjacent complementarity with respect to the stocks or by a sufficiently strong external effect of investment on the marginal product of physical capital or on the opportunity costs of investment.