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Compositional and dynamic Laffer effects in models with constant returns to scale

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  • Fredriksson, Anders

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    (Institute for international economic studies)

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    Abstract

    There is a renewed interest in the dynamic effects of tax cuts on government revenue. The possibility of tax cuts paying for themselves over time definitely seems like an attractive option for policy makers. This paper looks at what conditions are required for reductions in capital taxes to be fully self-financing. This is done in a model with constant returns to scale in broad capital. Such a framework exhibits growth; the scope for self-financing tax cuts is therefore different than in the neoclassical growth model, most recently studied by Mankiw and Weinzierl (2006). Compared to previous literature, I make a methodological contribution in the definition of "Laffer effects" and clarify the role of compositional and dynamic effects in making tax cuts self-financing. I also provide simple analytical expressions for what tax rates are required for tax cuts to be fully self-financing. The results show that large distortions are required to get Laffer effects. Introducing a labor/leisure choice into the model opens up a new avenue for such effects, however.

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    Bibliographic Info

    Paper provided by Stockholm University, Department of Economics in its series Research Papers in Economics with number 2007:2.

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    Length: 34 pages
    Date of creation: 23 Feb 2007
    Date of revision: 21 Apr 2007
    Handle: RePEc:hhs:sunrpe:2007_0002

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    Related research

    Keywords: Human capital; compositional effects from taxation; dynamic effects from taxation; Laffer effect; dynamic scoring;

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    1. Agell, J. & Persson, M., 2000. "On the Analytics of the Dunamic Laffer Curve," Papers 2000:5, Uppsala - Working Paper Series.
    2. Don Fullerton, 1982. "On the Possibility of an Inverse Relationship between Tax Rates and Government Revenues," NBER Working Papers 0467, National Bureau of Economic Research, Inc.
    3. Robert G. King & Sergio Rebelo, 1990. "Public Policy and Economic Growth: Developing Neoclassical Implications," NBER Working Papers 3338, National Bureau of Economic Research, Inc.
    4. Bianconi, Marcelo, 2000. "The effects of alternative fiscal policies on the intertemporal government budget constraint," International Review of Economics & Finance, Elsevier, vol. 9(1), pages 31-52, February.
    5. Pecorino, Paul, 1994. "The Growth Rate Effects of Tax Reform," Oxford Economic Papers, Oxford University Press, vol. 46(3), pages 492-501, July.
    6. Novales, Alfonso & Ruiz, Jesus, 2002. "Dynamic Laffer curves," Journal of Economic Dynamics and Control, Elsevier, vol. 27(2), pages 181-206, December.
    7. Ireland, Peter N., 1994. "Supply-side economics and endogenous growth," Journal of Monetary Economics, Elsevier, vol. 33(3), pages 559-571, June.
    8. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
    9. Pecorino, Paul, 1993. "Tax structure and growth in a model with human capital," Journal of Public Economics, Elsevier, vol. 52(2), pages 251-271, September.
    10. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : II. New directions," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 309-341.
    11. Nancy L. Stokey & Sergio Rebelo, 1993. "Growth Effects of Flat-Rate Taxes," NBER Working Papers 4426, National Bureau of Economic Research, Inc.
    12. Michael B. Devereux & David R. F. Love, 1994. "The Effects of Factor Taxation in a Two-Sector Model of Endogenous Growth," Canadian Journal of Economics, Canadian Economics Association, vol. 27(3), pages 509-36, August.
    13. Bruce, Neil & Turnovsky, Stephen J, 1999. "Budget Balance, Welfare, and the Growth Rate: "Dynamic Scoring" of the Long-Run Government Budget," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(2), pages 162-86, May.
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