A number of recent papers have investigated the growth effects of tax reforms in the context of neoclassical growth models where growth is due to human capital accumulation. Stokey and Rebelo (1995) show that the predicted growth effects disagree to a striking extent and are highly sensitive to the choices of several parameters about which little evidence exists. The purpose of this paper is to argue that the question should be reconsidered in the context of a life-cycle framework instead of the infinite horizon model used previously. Since human capital is not heritable, the infinite horizon case can no longer be derived as a reduced form of an altruistically linked dynasty of finitely lived individuals. Moreover, modeling agents as infinitely lived hides a fundamental asymmetry between human and physical capital: Since human capital cannot be sold or decumulated, agents must primarily use physical capital holdings to smooth consumption over the life-cycle and in particular to finance retirement consumption. As a consequence, changes in factor taxation mostly affect the stock of physical but not that of human capital. Correspondingly, our simulation results show that changes in flat rate factor taxation have little impact on long-run growth. In marked contrast to the previous literature, this result is remarkably robust to changes in the calibration and even to variations in the way human capital accumulation and intergenerational transfers are modeled. This strongly suggests that the large growth effects of taxation found previously overstate the true effect, perhaps by an order of magnitude. Much smaller effects are consistent with the observed stability of the U.S. growth trend in spite of dramatic increases in income tax rates after World War II.
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Paper provided by Arizona State University, Department of Economics in its series Working Papers with number
96/2.
Length: Date of creation: Date of revision: Handle: RePEc:wop:astewp:9602
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Find related papers by JEL classification: O41 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models
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Gary S. Becker & Nigel Tomes, 1994.
"X. Human Capital and the Rise and Fall of Families,"
NBER Chapters,
in: Human Capital: A Theoretical and Empirical Analysis with Special Reference to Education (3rd Edition), pages 257-298
National Bureau of Economic Research, Inc.
[Downloadable!]
Lutz Hendricks, 2001.
"Growth, Death, and Taxes,"
Review of Economic Dynamics,
Elsevier for the Society for Economic Dynamics, vol. 4(1), pages 26-57, January.
[Downloadable!] (restricted)
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Lutz Hendricks, 2001.
"Growth, Death, and Taxes,"
Review of Economic Dynamics,
Elsevier for the Society for Economic Dynamics, vol. 4(1), pages 26-57, January.
[Downloadable!] (restricted)
Other versions: