Capital Income Taxation and Aggregate Instability

Kevin X.D. Huang (), Qinglai Meng () and Jianpo Xue
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Kevin X.D. Huang: Vanderbilt University
Qinglai Meng: Oregon State University

No 19-00007, Vanderbilt University Department of Economics Working Papers from Vanderbilt University Department of Economics

Abstract: This paper overturns the conventional wisdom that reliance on capital tax rate adjustment to ensure fiscal sustainability is immune to extrinsic uncertainty. The interaction of capital taxation and endogenous capital utilization generates fiscal increasing returns and factor share redistribution to induce sunspots expectations. Capital depreciation allowance debilitates this mechanism to preempt policy induced instability while achieving budget objective. Self-fulfilling fluctuations can occur in real-world economies, unless their depreciation allowances are sufficiently higher or income tax rates lower than the current levels. This adds a short-run motivation to the long-run approach to capital taxation and the supply-side view of fiscal policy reforms.

Keywords: Capital income taxation; Depreciation allowance; Endogenous utilization; Fiscal increasing returns; Self-fulfilling prophecies (search for similar items in EconPapers)
JEL-codes: E3 E6 (search for similar items in EconPapers)
Date: 2019-03-27
New Economics Papers: this item is included in nep-acc, nep-dge, nep-mac and nep-pbe
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Persistent link: https://EconPapers.repec.org/RePEc:van:wpaper:vuecon-sub-19-00007

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