Endogenous Capital and the Output Cost of Taxation in HANK

This paper quantifies the output costs of taxation in a Heterogeneous Agent New Keynesian (HANK) model. In doing so, it compares a one-asset specification with fixed capital and an endogenous capital specification featuring Tobin's Q with two assets, both specifications sharing sticky wages and a common government budget specification. Normalizing the tax shocks, we find that a tax increase costs 0.13--0.20 percent of output on impact for the one-asset model, but 0.65 to 0.84 percent in the model with two assets and capital accumulation. In the one-asset model, the contraction isa consumption contraction, while progressive taxation is inflationary. In the model with endogenous capital, consumption rises by more than a percentage point of output, while Tobin's Q falls and investment declines by more than consumption gains, thus the entire output loss is an investment loss. Raising the same revenue progressively rather than proportionally changes the output response by less than 0.002 in either specification, while altering the distribution.