Increasing the Capital Income Tax Leads to Faster Growth
This paper shows that under rather mild conditions, higher capital income taxes lead to faster growth in an overlapping generations economy with endogenous growth. Government expenditures are financed with labor income taxes as well as capital income taxes. Since capital income accrues to the old, taxing it reliefs the tax burden on the young and leaves them with more income out of which to save. We argue that savings are sufficiently interest inelastic so that higher savings and therefore higher growth result. The basic argument is not seriously challenged by a grandfather clause for initial capital or by the old receiving some labor income as well. The reasoning is similar to Feldstein (1978), Auerbach (1979) and in particular Jones and Manuelli (1992), but in contrast to the conventional wisdom about the effect of capital income taxation as, say, in Lucas (1990).
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