The Fiscal State-Dependent Effects of Capital Income Tax Cuts

By Alexandra Fotiou, Wenyi Shen, Shu-Chun Susan Yang

May 29, 2020

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Alexandra Fotiou, Wenyi Shen, and Shu-Chun Susan Yang. The Fiscal State-Dependent Effects of Capital Income Tax Cuts, (USA: International Monetary Fund, 2020) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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.

Subject: Capital income tax, Consumption taxes, Corporate income tax, Fiscal consolidation, Fiscal policy, Public debt, Taxes

Keywords: Capital income tax, Capital income tax effect, Capital income tax effects, Consumption taxes, Corporate income tax, Cut effect, Cut increases government debt, Debt ratio, Fiscal consolidation, Fiscal policy, Fiscal policy effects, Income tax tax cut, Income tax tax rate, Non-linear DSGE model, Output multiplier, Rate data, Regime-switching models, Tax multiplier, Tax revenue, WP

Publication Details

Pages:

54
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/071
Stock No:

WPIEA2020071
ISBN:

9781513545868
ISSN:

1018-5941

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