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Does the Open Economy Assumption Really Mean That Labor Bears the Burden of a Capital Income Tax?

  • Gravelle Jane G


    (Congressional Research Service)

  • Smetters Kent A.


    (The Wharton School, University of Pennsylvania)

The conventional view holds that domestic labor, not domestic capital, bears most of the long-run burden of a corporate income tax in an open economy due to the ability of capital to move across borders. This result assumes that domestic and foreign products (as well as investments) are perfect substitutes. This paper includes imperfect product substitution within a multi-sector open-economy model, and shows that much of the burden may fall on capital. To be sure, if savings falls sufficiently, much of the burden shifts to labor, but this fact also holds in a closed economy. Hence, the debate about tax incidence must focus more on the savings response and less on whether an economy is open or closed.

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Article provided by De Gruyter in its journal The B.E. Journal of Economic Analysis & Policy.

Volume (Year): 6 (2006)
Issue (Month): 1 (August)
Pages: 1-44

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Handle: RePEc:bpj:bejeap:v:advances.6:y:2006:i:1:n:3
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