Taxation And Labor Supply Decisions: The Implications of Human Capital Accumulation .

 

 

 

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Taxation And Labor Supply Decisions: The Implications of Human Capital Accumulation

 

 

العنوان: Taxation And Labor Supply Decisions: The Implications of Human Capital Accumulation

WPS0205 :ISSN

الناشر : Arab Planning Institute - Kuwait

المؤلف (المؤلفين): Mustafa Babiker 

التاريخ: 2002

المحتويات :

The conventional literature on the effects of labor taxation has typically ignored the role of education and human capital accumulation. The recent development in growth theory with the reinterpretation of human capital as an engine of growth, however, has set the path for a rich research on taxation and labor supply decisions. Though this research is still in its early stages, it has contributed a lot to our understanding of the distortionary effects of labor taxation. In particular this research has shown that labor taxes do not only affect the current labor supply decisions but also affect the future supply decisions and the growth rate of the economy. Unfortunately, the details of these effects appear to vary considerably and indeed it is a primary concern of this paper to explain and reconcile these differences. The typical conflicting results in this newly born literature arise in relation to whether labor taxes are more or less distortionary than capital taxes, and to whether labor tax reform or capital tax reform has the most effect on economic growth. The recent papers by Lucas (1990), Pecorino (1994), Devereux and Love (1994), Wang and Yip (1995), and Ihori (1997) lie within this domain. Although all these authors have used more or less the same conventional setup of two-sector endogenous growth models, their conclusions differ widely.
Lucas (1990) has found that a revenue-neutral replacement of capital tax by labor tax has virtually no effect on the US growth rate. In contrast, Pecorino (1994) has found that such a replacement reduces the growth rate of the US economy. Devereux and Love (1994) have concluded that capital tax is the least efficient way of raising revenue compared to either a wage tax or a consumption tax. Yet, for Taiwan, Wang and Yip (1995) have shown that a shift from capital to labor income taxation retards economic growth. Not the end of the confusion, Ihori (1997) has found that, when bequests are not operative, a tax on human capital does not reduce growth but a tax on physical capital does.
The frustrating frequency of such conflicting results raises many doubts on the basic setup in these models and greatly undermines the usefulness of the endogenous growth framework for addressing important policy issues such as tax reform. Hence, understanding and sorting out the sources of these conflicting results is exercise worth of pursuing. Stokey and Rebelo (1995) have addressed these sources among the endogenous growth studies that have looked specifically on the tax reform question in US. They found that the conflicting results on the effect of tax reform on the US growth rate are solely explainable by the differences in model parameters that have been used in these studies. In particular, they found that parameters such as factor shares, depreciation rates, the elasticity of intertemporal substitution, and the elasticity of labor supply have critical leverage on the obtainable results in these models.Our objective in this paper, however, is more pedagogical. Different from Stokey and Rebelo (1995), our concern is to investigate more generally the implication of model parameters and assumptions in the generic endogenous growth setup for the conclusions to be drawn on the distortionary effects of labor vs. capital taxation. Also different from Stokey and Rebelo (1995) study, our focus is not limited to the steady state growth rates but, in addition, encompasses the growth effects during the transition to the steady state. Finally, different from all the aforementioned studies, our analysis, in addition to the growth effects, also accommodates the welfare impacts of taxes in these endogenous growth models. These latter two differences are particularly important and worth a brief comment at this stage. First, we find that the transitional impacts of different taxes on growth rates can be quite different in these models even when the steady state impacts are exactly identical. Second, in many instances, we find that the welfare effects can move in opposite direction to the growth effects when comparing the different tax packages. This suggests that two tax schemes that have identical steady-state effects may have quite different welfare implications. With this more general framework at hand, we are able to generate a range of possible outcomes on the distortionary effects of labor vs. capital taxation by only varying the representation of labor supply and the substitutability of labor and capital in the technology producing the consumption good. This range of outcomes accommodates virtually all the seemingly conflicting results in the literature reviewed at the beginning of this section.The rest of the paper is organized as follows. Section 2 presents a standard two-sector model of endogenous growth and conjectures the implications of labor and capital taxation in this setup. Section 3 develops a stylized dynamic general equilibrium model that captures the main features of the theoretical framework. Section 4 presents our simulation results, and section 5 provides some concluding remarks.