The Tax Cuts and Jobs Act (TCJA) : A Quantitative Evaluation

Should entrepreneurs be taxed preferentially over wage earners? The recent overhaul of the US tax code rekindles public debate surrounding differential taxation and fairness, since entrepreneurs receive more generous tax deductions. This paper then addresses the quantitative implications of a differential income taxation using a life cycle model with occupational choice and accumulation of entrepreneurial human capital. Calibrated to US data, the model economy shows as much heterogeneity within entrepreneurs’ group as within that of workers with respect to the effective tax burden. This provides rationale for alleviating taxation on entrepreneurs, at least, up to the median of the income distribution. When salient provisions of the Tax Cuts and Jobs Act (TCJA) are implemented, the economy experiences over a ten-year window, an average GDP growth rate of 0.64% and capital stock increases by 1.40%. These effects are reinforced in the long run given that output and capital stock grow on average by 1.7% and 4.5%, respectively. The 20%-deduction provision for entrepreneurs is the key driver of the TCJA’s effects since the corporate tax cut generates adverse outcomes. Nonetheless, economic growth is mitigated by a rise of inequality. On average, entrepreneurs are better off while workers experience welfare loss even with a wage increase of 2%. An optimal flat tax of 26.75% solely applied to entrepreneurs, surprisingly generates 2.4% reduction in output and is costly for poor-income individuals. On the welfare basis, preferential business income taxation over wage income does not have majority support.