Taxes and Capital Formation: How Important is Human Capital?

James Davies and John Whalley

No 2899, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper explores how explicit incorporation of human capital affects dynamic general equilibrium analysis of the effects of taxes on capital formation and welfare in a life-cycle growth model. In contrast to the results of partial equilibrium analysis, we find that estimates of the full dynamic welfare costs of capital income taxes are little affected by incorporating human capital. While the short-run impact effects of replacing income taxes with wage or consumption taxes are significantly affected by endogenizing human capital, these effects are short-lived. In the long-run the rate of return on non-human capital falls to approximately its initial net of tax level, and steady-state human capital investment plans are therefore little affected by the tax changes. Although incorporating human capital thus does not greatly alter results in our numerical simulations, a wide range of extensions and modifications of the model are discussed which could in principle modify this conclusion.

Date: 1989-03
Note: PE
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Published as National Saving and Economic Performance, eds. B. Douglas Bernheimand and John Shoven. Chicago: The University of Chicago Press, 1991.pp163-197.
Published as Taxes and Capital Formation: How Important is Human Capital? , James Davies, John Whalley. in National Saving and Economic Performance , Bernheim and Shoven. 1991

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