chirinko_00

Emory University
Department of Economics
Working Papers

Title: Tax Policy and Capital Formation under the EMU: Perspectives on German Economic Policy*

Number: 00-16

Author: Robert S.Chirinko

Issue Date: November 2000

Abstract: This paper develops a framework for considering capital formation and how it can be affected by tax policy. The economics literature is particularly useful in isolating the major channels through which tax policy affects capital formation and in focusing attention on the key empirical magnitudes that largely determine outcomes. The paper begins with a brief review of the empirical relations between capital formation, long-run growth, labor productivity. An essential question facing policymakers is then posed: is there too much or too little capital? Relevant theories are reviewed, and we adopt as an operating assumption that policymakers wish to increase capital formation. The three key channels translating tax policy into real outcomes are presented: a user cost channel linking tax policy to a measurable "price", a substitution channel quantifying the extent to which demanders and suppliers of capital respond to price incentives, and a production channel relating capital formation to output. This framework is used to discuss the impact of the EMU on tax policy effectiveness and to offer a perspective on current German policy initiatives -- business income tax cuts, capital gains forgiveness, energy tax increases, and labor market reforms.

* Forthcoming in Heinz Herrmann and Reiner Koenig (eds.), Investing Today For The World Of Tomorrow:
Proceedings Of The Second Annual German Bundesbank Spring Policy Conference
(Berlin: Springer-Verlag).

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Title:	Tax Policy and Capital Formation under the EMU: Perspectives on German Economic Policy*
Number:	00-16
Author:	Robert S.Chirinko
Issue Date:	November 2000
Abstract:	This paper develops a framework for considering capital formation and how it can be affected by tax policy. The economics literature is particularly useful in isolating the major channels through which tax policy affects capital formation and in focusing attention on the key empirical magnitudes that largely determine outcomes. The paper begins with a brief review of the empirical relations between capital formation, long-run growth, labor productivity. An essential question facing policymakers is then posed: is there too much or too little capital? Relevant theories are reviewed, and we adopt as an operating assumption that policymakers wish to increase capital formation. The three key channels translating tax policy into real outcomes are presented: a user cost channel linking tax policy to a measurable "price", a substitution channel quantifying the extent to which demanders and suppliers of capital respond to price incentives, and a production channel relating capital formation to output. This framework is used to discuss the impact of the EMU on tax policy effectiveness and to offer a perspective on current German policy initiatives -- business income tax cuts, capital gains forgiveness, energy tax increases, and labor market reforms.