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The Distributional Consequences of Supply-Side Reforms in General Equilibrium

  • Konstantinos Angelopoulos
  • Bernardo X. Fernandez
  • Jim Malley

Using a heterogeneous agent model allowing for different degrees of complementarity between capital, skilled and unskilled labour, this paper evaluates supply-side reforms consistent with lower public debt-to-GDP in the long-run. We find that, relative to the other tax reforms, capital tax cuts lead to the highest aggregate welfare but are skill-biased and can thus increase inequality in the long-run. Depending on the elasticity of substitution between capital and unskilled labour, falls in the capital tax can result in welfare losses for unskilled workers, even in the absence of other frictions and increases in other forms of taxation. On the other hand, reductions in labour taxes can hurt the capitalists. We also show that including the transition period in the welfare evaluation lowers the inequality effects of capital tax reduc-tions since the complementarity between capital and all labour inputs is higher in the short- than in the long-run. Finally, our results suggest that a form of "irrational exuberance" can arise after a tax cut under heterogeneous learning in the initial conditions after the reform.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2011/wp-cesifo-2011-06/cesifo1_wp3504.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3504.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3504
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  8. Cooley, T.F. & Hansen, G.D., 1991. "The Distortions in a Neoclassical Monetary Economy," Papers 91-01, Rochester, Business - General.
  9. Piketty, Thomas & Banerjee, Abhijit & Aghion, Philippe, 1997. "Dualism and macroeconomic volatility," CEPREMAP Working Papers (Couverture Orange) 9720, CEPREMAP.
  10. Konstantinos Angelopoulos & Jim Malley & Apostolis Philippopoulos, 2011. "Time-consistent Fiscal Policy under Heterogeneity: Conflicting or Common Interests?," CESifo Working Paper Series 3444, CESifo Group Munich.
  11. Juan C. Conesa & Dirk Krueger, 2004. "Taxing Capital: Not a Bad Idea After All," 2004 Meeting Papers 403, Society for Economic Dynamics.
  12. Angelopoulos, Konstantinos & Malley, James, 2008. "Tax Structure, Growth and Welfare in the UK," SIRE Discussion Papers 2008-18, Scottish Institute for Research in Economics (SIRE).
  13. Kevin J. Lansing, 1998. "Optimal redistributive capital taxation in a neoclassical growth model," Working Papers in Applied Economic Theory 99-01, Federal Reserve Bank of San Francisco.
  14. Teresa Garcia-Milà & Albert Marcet & Eva Ventura, 2010. "Supply Side Interventions and Redistribution," Economic Journal, Royal Economic Society, vol. 120(543), pages 105-130, 03.
  15. Juan Carlos Conesa & Timothy J. Kehoe & Kim J. Ruhl, 2007. "Modeling great depressions: the depression in Finland in the 1990s," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Nov, pages 16-44.
  16. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Learning stability in economics with heterogeneous agents," Working Paper Series 0120, European Central Bank.
  17. Guo, Jang-Ting & Lansing, Kevin J., 1999. "Optimal taxation of capital income with imperfectly competitive product markets," Journal of Economic Dynamics and Control, Elsevier, vol. 23(7), pages 967-995, June.
  18. Giannitsarou, Chryssi, 2006. "Supply-side reforms and learning dynamics," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 291-309, March.
  19. George W. Evans & Seppo Honkapohja & Kaushik Mitra, 2007. "Anticipated Fiscal Policy and Adaptive Learning," CDMA Working Paper Series 200717, Centre for Dynamic Macroeconomic Analysis.
  20. Per Krusell & Lee E. Ohanian & JosÈ-Victor RÌos-Rull & Giovanni L. Violante, 2000. "Capital-Skill Complementarity and Inequality: A Macroeconomic Analysis," Econometrica, Econometric Society, vol. 68(5), pages 1029-1054, September.
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  23. David Domeij & Jonathan Heathcote, 2004. "On The Distributional Effects Of Reducing Capital Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 523-554, 05.
  24. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
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