Capital Income Taxes and Growth in a Stochastic Economy: A Numerical Analysis of the Role of Risk Aversion and Intertemporal Substitution
University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics
University of California, Los Angeles (UCLA) - Anderson School of Management; Institute for the Study of Labor (IZA)
Stephen J. Turnovsky
University of Washington - Institute for Economic Research; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Journal of Public Economic Theory, Vol. 6, No. 2, pp. 277-310, May 2004
This paper undertakes a numerical analysis of the effects of changes in the tax rates on domestic and foreign capital income in a stochastically growing open economy under recursive preferences, in which the rate of time preference, epsilon, and the coefficient of risk aversion, R, can be set independently. The responses of the equilibrium growth rate, its volatility, and welfare to changes in the tax changes considered are highly sensitive to the independent variations in both epsilon and R. Consequently, the errors committed by using the conventional constant elasticity utility function, even for small violations of the compatibility condition (R = 1/epsilon) can be significant, suggesting that this functional form should be employed with caution.
Keywords: Recursive Preferences, Stochastic Growth, Time Preference, Risk Aversion, Volatility, Tax Policy
JEL Classification: D900, E620, F430, H240, H250, O410Accepted Paper Series
Date posted: December 11, 2004
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