SFB 303 Discussion Paper No. A - 522

Author: Grüner, Hans Peter, and Burkhard Heer
Title: Should Capital be Taxed?
Abstract: We examine the transitional dynamics of Lucas' (1990) supply side model of the US economy in order to specify the effects of capital taxation on economic growth and welfare. We restrict the analysis to policy plans characterized by constant capital taxes and demand the government to maintain a balanced budget. Under these restrictions, abandoning capital income taxation decreases welfare. It positively affects generational welfare in the medium run, but not in the long run. The optimal tax rate on capital is shown to be above its current US level. Welfare can further be increased by the introduction of a tax on asset holdings. Taking into account that capital taxation reduces the need for redistribution and, hence, the size of the government transfers, we show that capital taxes have significant positive growth effects. This holds even for small values of both the elasticity of labor supply and the elasticity of intertemporal substitution.
Keywords: Capital Taxation, Income Taxation, Inequality, Endogenous Growth, Optimal Taxation
JEL-Classification-Number: E61, E62, H21, H23, O41
Creation-Date: May 1996
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