Macroeconomic Effects of Capital Tax Rate Changes

105 Pages Posted: 30 Jun 2020

See all articles by Saroj Bhattarai

Saroj Bhattarai

University of Texas at Austin - Department of Economics

Jae Won Lee

University of Virginia - Department of Economics

Woong Yong Park

Seoul National University

Choongryul Yang

Federal Reserve Board of Governors

Multiple version iconThere are 2 versions of this paper

Date Written: June, 2020

Abstract

We study aggregate, distributional and welfare effects of a permanent reduction in the capital tax rate in a quantitative equilibrium model with capital-skill complementarity. Such a tax reform leads to expansionary long-run aggregate effects, but is coupled with an increase in wage and income inequality. Moreover, the expansionary aggregate effects are smaller when distortionary labor or consumption tax rates have to increase to finance the capital tax rate cut, driven by effects on labor supply decisions. An extension to a model with heterogeneous households shows that consumption inequality also increases in the long run, which leads to a further rise in wage inequality. We study transition dynamics and show that joint modeling of monetary and fiscal policy response is important for analyzing short-run effects. Finally, we contrast the long-term aggregate welfare gains with short-term losses, regardless of how the tax cut is financed. In the model with heterogeneous households, we additionally show that welfare gains for the skilled go together with welfare losses for the unskilled.

Keywords: Capital tax rate, Capital-skill complementarity, Inequality, Transition dynamics, Welfare implications

JEL Classification: E62, E63, E52, E58, E31

Suggested Citation

Bhattarai, Saroj and Lee, Jae Won and Park, Woong Yong and Yang, Choongryul, Macroeconomic Effects of Capital Tax Rate Changes (June, 2020). Globalization and Monetary Policy Institute Working Paper No. 391, Available at SSRN: https://ssrn.com/abstract=3638871 or http://dx.doi.org/10.24149/gwp391

Saroj Bhattarai (Contact Author)

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

Jae Won Lee

University of Virginia - Department of Economics ( email )

237 Monroe Hall
P.O. Box 400182
Charlottesville, VA 22904-418
United States

Woong Yong Park

Seoul National University ( email )

Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

Choongryul Yang

Federal Reserve Board of Governors ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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