Macroeconomic Effects of Capital Tax Rate Changes

Saroj Bhattarai, Jae Won Lee, Woong Yong Park and Choongryul Yang

No 2022-027, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We study aggregate, distributional, and welfare effects of a permanent reduction in the capital tax rate in a quantitative model with capital-skill complementarity and household heterogeneity. Such a tax reform leads to expansionary long-run aggregate output and investment effects, but those are coupled with increases in wage, consumption, and income inequality. The tax reform is not self-financing and its effects depend crucially on whether the government cuts lump-sum transfers or raises distortionary labor or consumption tax rates for financing. The former results in a larger aggregate expansion, but at the expense of a greater rise in inequality. As a result, the latter is relatively more beneficial for unskilled households. We find that the tax reform, when the consumption tax rate adjusts, leads to a Pareto improvement in terms of life-time welfare. For transition dynamics, monetary policy, in addition to the fiscal adjustments, matters. In particular, if monetary policy inflates away a portion of the public debt, the economy can avoid the short-run contraction that would arise otherwise.

Keywords: Capital tax rate; Distortionary financing; Capital-skill complementarity; Inequality; Welfare implications (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 E62 E63 (search for similar items in EconPapers)
Pages: 70 p.
Date: 2022-05-20
New Economics Papers: this item is included in nep-dge, nep-mac, nep-pbe and nep-pub
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Citations: View citations in EconPapers (3)

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https://www.federalreserve.gov/econres/feds/files/2022027pap.pdf (application/pdf)

Related works:
Working Paper: Macroeconomic Effects of Capital Tax Rate Changes (2020)
Working Paper: Macroeconomic effects of capital tax rate changes (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2022-27

DOI: 10.17016/FEDS.2022.027

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