Lessons for Tax Reform from an Equilibrium Model of Innovation

48 Pages Posted: 19 Feb 2019

See all articles by Domenico Ferraro

Domenico Ferraro

Arizona State University (ASU) - Economics Department

Soroush Ghazi

University of Alabama - Department of Economics, Finance and Legal Studies

Pietro F. Peretto

Duke University - Department of Economics; Duke Innovation & Entrepreneurship Initiative

Date Written: January 26, 2019

Abstract

We formulate and estimate a general equilibrium model of innovation-led growth and use it to evaluate the quantitative implications of individual income tax reforms for innovation and aggregate productivity growth. In the model, innovation comes from entrants creating new products and incumbents improving own existing products. We estimate the model parameters by matching key moments of U.S. data. The model generates an aggregate labor supply elasticity and a per capita GDP growth response to marginal tax rate changes that are consistent with available empirical estimates. We find that the model accounts reasonably well for the observed movements in TFP, labor productivity, hours worked and number of firms per capita during the “Reagan tax cuts” of the eighties. The model predicts that a temporary, deficit-financed, 3 percentage points cut in the average marginal individual income tax rate, set to expire in 2025, produces a temporary TFP growth acceleration leading to a 6 percent increase in real per capita GDP by year 2040.

Keywords: Individual income tax; Economic growth; Total factor productivity; Firms’ entry; Innovation; R&D

JEL Classification: E23; E24; E62; O30; O40

Suggested Citation

Ferraro, Domenico and Ghazi, Soroush and Peretto, Pietro F., Lessons for Tax Reform from an Equilibrium Model of Innovation (January 26, 2019). Economic Research Initiatives at Duke (ERID) Working Paper No. 282 (2019), Available at SSRN: https://ssrn.com/abstract=3325987 or http://dx.doi.org/10.2139/ssrn.3325987

Domenico Ferraro

Arizona State University (ASU) - Economics Department ( email )

Tempe, AZ 85287-3806
United States

Soroush Ghazi

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States

HOME PAGE: http://sites.google.com/view/soroush-ghazi

Pietro F. Peretto (Contact Author)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States
919-660-1807 (Phone)
919-684-8974 (Fax)

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

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