What Do Aggregate Consumption Euler Equations Say About the Capital Income Tax Burden?
12 Pages Posted: 19 Jul 2010 Last revised: 27 Dec 2011
Date Written: February 2004
Aggregate consumption Euler equations fit financial asset return data poorly. But they fit the return on the capital stock well, which leads us to three empirical findings relating to the capital income tax burden. First, capital taxation drives a wedge between consumption growth and the expected pre-tax capital return. Second, capital taxation is the major distortion in the capital market, in the sense that most of the medium and long run deviations between expected consumption growth and the expected pre-tax capital return are associated with capital taxation. Third, consumption growth appears to be pretty elastic to the after-tax capital return (i.e., capital is elastically supplied), even while it appears inelastic to returns on various financial assets. Capital income taxes are passed on through reduced capital accumulation, or higher markups, or some combination.
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