## The Dynamic Macroeconomic Effects of Tax Policy in an Overlapping Generations Model

_IMF Working Papers, December 1, 1998_

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## Bibliographic details
- Authors: Ben J. Heijdra, Jenny E Ligthart
- Published: December 1, 1998
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451859249.001

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### Summary
- Studies dynamic allocation effects of tax policy in an overlapping generations model of the Blanchard-Yaari type.
- Extends the model to allow for endogenous labor supply and three tax instruments: a capital income tax, labor income tax, and consumption tax.
- Uses analytical expressions and simple diagrams to discuss impact, transition, and long-run effects of tax policy changes.
- Key result: a part of the long-run incidence of capital and consumption taxes falls on capital when households’ horizons are finite, whereas labor would fully bear the burden of these taxes in an infinite horizon model.

### Model features and methods
- Model: overlapping generations (Blanchard-Yaari type).
- Behavioral margins: endogenous labor supply.
- Tax instruments: capital income tax, labor income tax, consumption tax.
- Analytical approach: closed-form analytical expressions and illustrative diagrams to trace impact, transition dynamics, and long-run equilibria.

### Main findings and implications
- Long-run incidence of capital and consumption taxes:
  - With finite household horizons: part of the long-run incidence falls on capital.
  - With infinite horizon models: labor would fully bear the burden of capital and consumption taxes.
- Transition dynamics and allocation effects are analyzed to show how tax changes propagate over time through capital accumulation, labor supply, and interest rates.
- Emphasizes the role of household horizon assumptions (finite vs. infinite) in determining distribution of tax burdens between capital and labor.

### Policy-relevant insights
- Tax policy evaluation must account for household lifetime horizon assumptions when attributing incidence between capital and labor.
- Distinguishing between short-run transition effects and long-run incidence is crucial for designing tax instruments (capital income tax, labor income tax, consumption tax) and anticipating their distributional consequences.
- Endogenous labor supply alters how tax changes affect allocations and welfare relative to models with exogenous labor supply.

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