The Fiscal State-Dependent Effects of Capital Income Tax Cuts

Author/Editor:

Alexandra Fotiou ; Wenyi Shen ; Shu-Chun Susan Yang

Publication Date:

May 29, 2020

Electronic Access:

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Summary:

Using the post-WWII data of U.S. federal corporate income tax changes, within a Smooth Transition VAR, this paper finds that the output effect of capital income tax cuts is government debt-dependent: it is less expansionary when debt is high than when it is low. To explore the mechanisms that can drive this fiscal state-dependent tax effect, the paper uses a DSGE model with regime-switching fiscal policy and finds that a capital income tax cut is stimulative to the extent that it is unlikely to result in a future fiscal adjustment. As government debt increases to a sufficiently high level, the probability of future fiscal adjustments starts rising, and the expansionary effects of a capital income tax cut can diminish substantially, whether the expected adjustments are through a policy reversal or a consumption tax increase. Also, a capital income tax cut need not always have large revenue feedback effects as suggested in the literature.

Series:

Working Paper No. 20/71

Subject:

English

Publication Date:

May 29, 2020

ISBN/ISSN:

9781513545868/1018-5941

Stock No:

WPIEA2020071

Format:

Paper

Pages:

54

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