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A General Equilibrium Model of Taxation with Endogenous Financial Behavior

In: Behavioral Simulation Methods in Tax Policy Analysis

  • Joel B. Slemrod

This paper presents and utilizes a new general equilibrium simulation model of capital income taxation. Its chief advantage over existing models of the effects of taxation is that it recognizes that agents may adjust their financial behavior in response to changes in the way that capital income is taxed. By integrating a structural treatment of portfolio choice and financial markets into a standard multi-sector model of taxation, the model can trace the general equilibrium impact of these financial adjustments and calculate the tax-induced changes in the allocation of factors and output as well as the distributional effects of any tax change. The model is used to simulate the impact of completely indexing the tax system for inflation. The results indicate there would be significant financial adjustment in response to indexing. A large shift in the distribution of private risk bearing accompanies a slight reallocation of the capital stock away from owner-occupied housing toward its other uses and a substantial change in the ownership of the housing stock by income class. All in all, indexing the tax system of an economy like the U.S. in 1977 seems to lead to an efficiency gain, slightly hurts the lowest income classes, and substantially improves the welfare of the highest income groups. The simulation results should, however, be considered tentative due to uncertainty about the values of several parameters and the relatively simple formulations of the determinants of portfolio choice and the U.S. financial structure.

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This chapter was published in:
  • Martin Feldstein, 1983. "Behavioral Simulation Methods in Tax Policy Analysis," NBER Books, National Bureau of Economic Research, Inc, number feld83-2, August.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 7715.
    Handle: RePEc:nbr:nberch:7715
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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    1. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 28-43 National Bureau of Economic Research, Inc.
    2. Shoven, John B. & Whalley, John, 1972. "A general equilibrium calculation of the effects of differential taxation of income from capital in the U.S," Journal of Public Economics, Elsevier, vol. 1(3-4), pages 281-321, November.
    3. Feldstein, Martin S & Green, Jerry R & Sheshinski, Eytan, 1978. "Inflation and Taxes in a Growing Economy with Debt and Equity Finance," Journal of Political Economy, University of Chicago Press, vol. 86(2), pages S53-70, April.
    4. Feldstein, Martin S & Slemrod, Joel, 1980. "Personal Taxation, Portfolio Choice, and the Effect of the Corporation Income Tax," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 854-66, October.
    5. McLure, Charles Jr., 1975. "General equilibrium incidence analysis : The Harberger model after ten years," Journal of Public Economics, Elsevier, vol. 4(2), pages 125-161, February.
    6. Irwin Friend & Joel Hasbrouck, . "Effect of Inflation on the Profitability and Valuation of U.S. Corporations," Rodney L. White Center for Financial Research Working Papers 13-80, Wharton School Rodney L. White Center for Financial Research.
    7. Alan J. Auerbach, 1980. "Wealth Maximization and the Cost of Capital," NBER Working Papers 0254, National Bureau of Economic Research, Inc.
    8. Charles L. Ballard & Don Fullerton & John B. Shoven & John Whalley, 1985. "Replacing the Personal Income Tax with a Progressive Consumption Tax," NBER Chapters, in: A General Equilibrium Model for Tax Policy Evaluation, pages 171-187 National Bureau of Economic Research, Inc.
    9. Alan J. Auerbach & Mervyn A. King, 1984. "Taxation, Portfolio Choice, and Debt-Equity Ratios: A General Equilibrium Model," NBER Working Papers 0546, National Bureau of Economic Research, Inc.
    10. Rosen, Harvey S & Rosen, Kenneth T, 1980. "Federal Taxes and Homeownership: Evidence from Time Series," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 59-75, February.
    11. King, Mervyn A, 1974. "Taxation and the Cost of Capital," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 21-35, January.
    12. Martin Feldstein & Lawrence Summers, 1983. "Inflation and the Taxation of Capital Income in the Corporate Sector," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 116-152 National Bureau of Economic Research, Inc.
    13. Shoven, John B, 1976. "The Incidence and Efficiency Effects of Taxes on Income from Capital," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1261-83, December.
    14. Joseph E. Stiglitz, 1970. "Taxation, Risk-Taking, and the Allocation of Investment," Cowles Foundation Discussion Papers 305, Cowles Foundation for Research in Economics, Yale University.
    15. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, vol. 65(5), pages 900-922, December.
    16. David F. Bradford, 1979. "The Incidence and Allocation Effects of a Tax on Corporate Distributions," NBER Working Papers 0349, National Bureau of Economic Research, Inc.
    17. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
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