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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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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3504.

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Date of creation: 2011
Date of revision:
Handle: RePEc:ces:ceswps:_3504
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  1. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2007. "Taxing Capital? Not a Bad Idea After All!," NBER Working Papers 12880, National Bureau of Economic Research, Inc.
  2. Konstantinos Angelopoulos & Jim Malley & Apostolis Philippopoulos, 2008. "Tax Structure, Growth and Welfare in the UK," Working Papers 2008_05, Business School - Economics, University of Glasgow, revised Apr 2008.
  3. Kaushik Mitra & Seppo Honkapohja, 2004. "Learning Stability in Economies with Heterogenous Agents," Royal Holloway, University of London: Discussion Papers in Economics 04/17, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  4. 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.
  5. Paul Klein & Per Krusell & José-V�ctor R�os-Rull, 2008. "Time-Consistent Public Policy," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 789-808.
  6. Teresa Garcia-Milà & Albert Marcet & Eva Ventura, 1995. "Supply side interventions and redistribution," Economics Working Papers 115, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Piketty, Thomas & Banerjee, Abhijit & Aghion, Philippe, 1997. "Dualism and macroeconomic volatility," CEPREMAP Working Papers (Couverture Orange) 9720, CEPREMAP.
  8. Per Krusell & Lee E. Ohanian & Jose-Victor Rios-Rull & Giovanni L. Violante, 1997. "Capital-skill complementarity and inequality: a macroeconomic analysis," Staff Report 239, Federal Reserve Bank of Minneapolis.
  9. Jang-Ting Guo & Kevin J. Lansing, 1998. "Optimal taxation of capital income with imperfectly competitive product markets," Working Papers in Applied Economic Theory 98-04, Federal Reserve Bank of San Francisco.
  10. Juan Carlos Conesa & Timothy J. Kehoe & Kim J. Ruhl, 2007. "Modeling great depressions: the depression in Finland in the 1990s," Staff Report 401, Federal Reserve Bank of Minneapolis.
  11. Stephanie Schmitt-Grohe & Martin Uribe, 1995. "Balanced-budget rules, distortionary taxes, and aggregate instability," Finance and Economics Discussion Series 95-44, Board of Governors of the Federal Reserve System (U.S.).
  12. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2006. "Adaptive Learning in Practice," CEPR Discussion Papers 5627, C.E.P.R. Discussion Papers.
  13. George W. Evans & Seppo Honkapohja & Kaushik Mitra, 2007. "Anticipated Fiscal Policy and Adaptive Learning," University of Oregon Economics Department Working Papers 2007-5, University of Oregon Economics Department, revised 13 Dec 2008.
  14. 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.
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  18. repec:oup:restud:v:60:y:1993:i:1:p:35-52 is not listed on IDEAS
  19. Eva Carceles Poveda & Chryssi Giannitsarou, 2006. "Asset pricing with adaptive learning," Computing in Economics and Finance 2006 25, Society for Computational Economics.
  20. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
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  22. Giannitsarou, Chryssi, 2006. "Supply-side reforms and learning dynamics," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 291-309, March.
  23. 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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