Working Paper: NBER ID: w2553
Authors: Patric H. Hendershott
Abstract: Early tax reform proposals listed economic growth as a major goal, and some even gave explicit estimates of the expected increase in the long run output path that would follow from enactment. The 1986 Tax Act does not mention growth, much less give estimates of the expected increase, for good reason. The 1986 Tax Act will likely reduce the long-run output path by two to four percent. A revenue-neutral tax reform that raises the standard deduction and personal exemption cannot, in general, increase the bundle of goods one can purchase with an additional hour worked. Cuts in marginal personal tax rates can be achieved by broadening the tax base and shifting the tax burden to businesses. However, while the after-tax wage will increase, so will the after-tax cost of goods consumed, both currently and in the future, and thus work effort is unlikely to rise. Similarly, a tax reform that shifts the tax burden from labor and existing capital to new investments will likely lower saving and reallocate capital away from industrial uses. While the Tax Act will increase the efficiency of business investment, the potential efficiency gains are so small that actual gains will be swamped by the direct effect of a smaller business capital stock.
Keywords: Tax Reform; Economic Growth; Labor Supply; Investment
JEL Codes: H24; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lower marginal tax rates (H29) | increased labor supply (J20) |
| Tax Reform Act of 1986 (H20) | reduced long-run output path (E23) |
| increased after-tax wages (J39) | diminished work effort (J22) |
| tax reforms (H29) | increased after-tax wages (J39) |
| tax reforms (H29) | elevated after-tax cost of goods (H29) |
| broadening tax base and lowering marginal tax rates (H29) | no increased labor supply (J20) |
| disallowance of deductions or taxing previously untaxed capital income (H26) | neutralize benefits of lower tax rates (H20) |
| efficiency gains from reallocating capital (D61) | overshadowed by negative impacts on business investment (F69) |
| tax changes (H26) | no significant effect on personal saving rates (D14) |