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Promoting Investment under International Capital Mobility: An Intertemporal General Equilibrium Analysis

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  • A. Lans Bovenberg
  • Lawrence H. Goulder

Abstract

This paper uses a dynamic computable general equilibrium model to compare, in an economy open to international capital flows, the effects of two U.S. policies intended to promote domestic capital formation. The two policies -- the introduction of an investment tax credit (ITC) and a reduction in the statutory corporate income tax rate -- differ in their treatment of old (existing) and new capital. The model features adjustment dynamics, intertemporal optimization by U.S. and foreign households and firms endowed with model-consistent expectations, imperfect substitution between domestic and foreign assets in portfolios, an integrated treatment of the current and capital accounts of the balance of payments, and industry disaggregation in the United States. We find that the two policies (scaled to imply the same revenue cost) differ in their consequences for foreign and domestic welfare, the balance of payments accounts, international competitiveness, and U.S. industrial structure. The ITC produces larger domestic welfare gains because it is more effective in reducing intertemporal distortions, while the two policies have similar implications for intersectoral efficiency. From the point of view of domestic welfare, the relative attractiveness of the ITC is enhanced when international capital mobility is taken into account, a reflection of international transfers of wealth associated with foreign ownership of part of the U.S. capital stock. Whereas reducing the corporate tax rate improves the trade balance initially, introducing the ITC causes a deterioration of the trade balance in the short run. Reflecting a lower real exchange rate, export-oriented sectors perform better relative to non-tradable industries under a lower corporate tax rate than in the presence of the lTC, especially in the short run.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3139.

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Date of creation: Oct 1989
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Handle: RePEc:nbr:nberwo:3139

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  1. James M. Poterba & Julio J. Rotemberg, 1988. "Money in the Utility Function: An Empirical Implementation," NBER Working Papers 1796, National Bureau of Economic Research, Inc.
  2. Mussa, Michael, 1978. "Dynamic Adjustment in the Heckscher-Ohlin-Samuelson Model," Journal of Political Economy, University of Chicago Press, vol. 86(5), pages 775-91, October.
  3. Darrell Duffie & William Zame, 1988. "The Consumption-Based Capital Asset Pricing Model," Discussion Papers 88-10, University of Copenhagen. Department of Economics.
  4. Roger H. Gordon & James R. Hines, Jr. & Lawrence H. Summers, 1987. "Notes on the Tax Treatment of Structures," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 223-258 National Bureau of Economic Research, Inc.
  5. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-85, July.
  6. Robert C. Feenstra, 1989. "Trade Policies for International Competitiveness," NBER Books, National Bureau of Economic Research, Inc, number feen89-1, October.
  7. James M. Poterba & Lawrence H. Summers, 1984. "The Economic Effects of Dividend Taxation," Working papers 343, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
  9. Jorgenson, Dale W & Yun, Kun-Young, 1986. " The Efficiency of Capital Allocation," Scandinavian Journal of Economics, Wiley Blackwell, vol. 88(1), pages 85-107.
  10. Bovenberg, A Lans, 1989. "The Effects of Capital Income Taxation on International Competitiveness and Trade Flows," American Economic Review, American Economic Association, vol. 79(5), pages 1045-64, December.
  11. Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-84, June.
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Cited by:
  1. Philippe Thalmann & Lawrence Goulder & François Delorme, 1996. "Assessing the international spillover effects of capital income taxation," International Tax and Public Finance, Springer, vol. 3(4), pages 449-478, October.
  2. Brita Bye & Taran Fæhn & Tom-Reiel Heggedal, 2007. "Welfare and growth impacts of innovation policies in a small, open economy. An applied general equilibrium analysis," Discussion Papers 510, Research Department of Statistics Norway.
  3. Brita Bye & Turid Åvitsland, 2001. "The welfare effects of housing taxation in a distorted economy: A general equilibrium analysis," Discussion Papers 306, Research Department of Statistics Norway.
  4. Willenbockel, Dirk, 1999. "Dynamic applied general equilibrium trade policy analysis in the presence of foreign asset cross-ownership," Economic Modelling, Elsevier, vol. 16(3), pages 371-388, August.
  5. Bye, Brita & Avitsland, Turid, 2003. "The welfare effects of housing taxation in a distorted economy: a general equilibrium analysis," Economic Modelling, Elsevier, vol. 20(5), pages 895-921, September.
  6. Bye, Brita & Fæhn, Taran & Heggedal, Tom-Reiel, 2009. "Welfare and growth impacts of innovation policies in a small, open economy; an applied general equilibrium analysis," Economic Modelling, Elsevier, vol. 26(5), pages 1075-1088, September.
  7. A. Lans Bovenberg, 1992. "Residence-and source-based taxation of capital income in an overlapping generations model," Journal of Economics, Springer, vol. 56(3), pages 267-295, October.
  8. Jensen, Svend Erik Hougaard & Bo Nielsen, Soren & Pedersen, Lars Haagen & Sorensen, Peter Birch, 1996. "Tax policy, housing and the labour market: An intertemporal simulation approach," Economic Modelling, Elsevier, vol. 13(3), pages 355-382, July.
  9. Klundert, T.C.M.J. van de, 1990. "Crowding out and the wealth of nations," Discussion Paper 1990-29, Tilburg University, Center for Economic Research.
  10. Valkonen, Tarmo, 2000. "Shifting the tax burden from labour to capital in general equilibrium," Discussion Papers 702, The Research Institute of the Finnish Economy.

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