Income Taxation

After a brief survey of the empirical findings on income taxation in the US and German economies in Sect. 5.2, you learn about the substantial welfare costs that are associated with the taxation of labor income. In Sect. 5.3, these costs are computed in both partial and general equilibrium. As one result, the deadweight loss of labor income taxation in Germany is found to be twice as high as the one in the US. In Sect. 5.4, the seminal result from optimal taxation that capital income should not be taxed in the long run is derived and discussed critically. Section 5.5 estimates the US Laffer curve and shows that the US government, in contrast to many European governments, can still raise its revenues from labor and capital income taxation by approximately 10% of GDP. In Sect. 5.6, the quantitative effects of higher taxes on economic growth are derived in a Dynamic General Equilibrium (DGE) model and are shown to be substantially higher than those typically found in growth regressions. Finally, we demonstrate that stochastic taxes improve the time series properties of the real business cycle (RBC) model with respect to the volatility of aggregate demand components and the dynamics of labor and wages in Sect. 5.7.