Ad valorem versus unit taxes on capital in a dynamic stochastic general equilibrium model

Shiou-Yen Chu () and Tsaur-Chin Wu ()
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Shiou-Yen Chu: National Chengchi University
Tsaur-Chin Wu: Feng Chia University, Xitun District

International Tax and Public Finance, 2023, vol. 30, issue 6, No 1, 1435-1456

Abstract: Abstract This paper is the first attempt to adopt a dynamic stochastic general equilibrium (DSGE) framework with nominal price rigidity and monopolistic competition to compare the macroeconomic effects of unit and ad valorem capital taxes. Our results show that the welfare dominance between an ad valorem tax and a unit tax depends on their relative marginal costs. A higher marginal cost resulting from an increase in capital tax generates less consumption and more labor hours, leading to lower welfare. This result is robust to a varying elasticity of intertemporal substitution in consumption and a varying Frisch elasticity of labor supply, a varying degree of price rigidity and productive versus nonproductive public capital. In response to positive government spending shocks, our results indicate that when the increase in government spending is totally financed via capital taxation, a unit tax is superior to an ad valorem tax.

Keywords: Capital tax; DSGE; Price rigidity; Government spending (search for similar items in EconPapers)
JEL-codes: E62 H20 H32 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s10797-022-09764-8

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