The Fiscal State-Dependent Effects of Capital Income Tax Cuts

Alexandra Fotiou, Wenyi Shen and Shu-Chun Yang

No 2020/071, IMF Working Papers from International Monetary Fund

Abstract: Using the post-WWII data of U.S. federal corporate income tax changes, within a Smooth Transition VAR, this paper finds that the output effect of capital income tax cuts is government debt-dependent: it is less expansionary when debt is high than when it is low. To explore the mechanisms that can drive this fiscal state-dependent tax effect, the paper uses a DSGE model with regime-switching fiscal policy and finds that a capital income tax cut is stimulative to the extent that it is unlikely to result in a future fiscal adjustment. As government debt increases to a sufficiently high level, the probability of future fiscal adjustments starts rising, and the expansionary effects of a capital income tax cut can diminish substantially, whether the expected adjustments are through a policy reversal or a consumption tax increase. Also, a capital income tax cut need not always have large revenue feedback effects as suggested in the literature.

Keywords: WP; debt ratio; capital income tax effects; tax multiplier; fiscal policy effects; regime-switching models; non-linear DSGE model; income tax tax cut; income tax tax rate; cut effect; fiscal policy; rate data; tax revenue; capital income tax effect; cut increases government debt; output multiplier; Capital income tax; Fiscal consolidation; Corporate income tax; Consumption taxes (search for similar items in EconPapers)
Pages: 54
Date: 2020-05-29
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Citations: View citations in EconPapers (15)

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Journal Article: The fiscal state-dependent effects of capital income tax cuts (2020)
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