The Effects of Taxation on Capital Accumulation | Date: 28 April 2011, 07:25
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The Effects of Taxation on Capital Accumulation (National Bureau of Economic Research Monographs)
By Martin Feldstein
* Publisher: Univ of Chicago Pr (Tx)
* Number Of Pages: 480
* Publication Date: 1987-07
* ISBN-10 / ASIN: 0226240886
* ISBN-13 / EAN: 9780226240886
Introduction
Martin Feldstein
Capital formation has long been a central focus of the research of the
National Bureau because of the central role of capital accumulation in
the process of economic growth. NBER studies in this area, including
the work of Simon Kuznets, Raymond Goldsmith, and Milton Friedman,
have focused on the determinants of saving as well as on the
process of investment in plant and equipment.
A high saving rate leads to a high rate of investment in plant and
equipment and in housing since the increased flow of saving reduces
the equilibrium cost of funds to prospective borrowers. The rate of
saving is, of course, influenced by many factors in addition to the tax
rules emphasized in the current volume. Demographic factors, retirement
arrangements, and public and private pension systems have an
important independent influence. Tax rules, as the evidence in this
volume indicates, are important because they affect the return that
savers receive in exchange for postponing consumption.
Investment in plant and equipment is a critical aspect of economic
activity, for it contributes directly to raising productivity and therefore
to raising the nation's standard of living. An increase in saving does
not automatically produce a rise in such investment, however; the
savings can go instead into housing or foreign investment. A variety
of factors influence the division of the nation's capital stock between
plant and equipment, housing and foreign investment. These factors
can be summarized as affecting the relative profitability and riskiness
of alternative types of investments. The studies in this volume deal
with the way taxes affect the profitability of different investments and
the impact of those profitability differences on the allocation of the
capital stock.
A finding common to several of these studies is that the process of
capital formation is quite sensitive to tax rules. With respect to personal
saving, Steven Venti and David Wise report an analysis of new survey
evidence that indicates that Individual Retirement Accounts have a
powerful effect on personal wealth accumulation. They estimate, for
example, that an increase in the annual IRA contribution limits would
significantly raise contributions, with about half of that increased contribution
coming from reduced consumption and most of the remainder
coming from reduced tax liabilities. Relatively little of the increased
IRA contributions would come from reductions in other types of saving.
Thus a rise in the IRA contribution limits would raise national saving
even though it reduced tax revenue.
A quite different type ofevidence on the sensitivity ofpersonal saving
to tax rules is provided by Gregory Mankiw's analysis of the effects
of the after-tax interest rate on consumer durable spending. Mankiw's
analysis indicates that the after-tax interest rate is an important determinant
of consumer spending, especially spending on consumer durabIes.
This implies that tax policies that raise the after-tax return on
saving, like the IRA or a partial exclusion of personal interest income,
would stimulate personal saving. Similarly, the proposal to eliminate
or limit the deductibility of consumer interest would reduce consumer
borrowing and raise the net saving rate.
Lawrence Lindsey analyzes the long-term capital gains reported in
each tax bracket in every year since 1965. This important body of
aggregate data by income class has confirmed the finding of previous
studies based on individual tax returns and on household survey data
that the decision to realize capital gains is quite sensitive to effective
tax rates on realized gains. Lindsey calculates that the sensitivity to
high capital gains tax rates is such that a capital gains tax rate above
20% reduces total tax revenue.
My own study with Joosung Jun examines the relationship between
tax-induced changes in the net profitability of investment during the
past three decades and the share of GNP devoted to net investment in
plant and equipment. The evidence indicates a powerful effect of tax
rules on business investment that is consistent with past research and
with the rise in net investment in the 1980s. Our analysis implies that
the types of changes in tax rules that have recently been proposed by
the Reagan Administration and legislated by the House of Representatives
would significantly reduce business fixed investment. The eventual
effect would be to reduce such investment by approximately the
full amount of the additional corporate tax revenue.
The frequent changes in tax rules have sensitized businesses to the
possibility that existing tax rates and tax rules are subject to change.
Alan Auerbach and James Hines analyze the response of business
investment to anticipated changes in tax rules and conclude that business
investment responds to anticipated tax changes as well as to existing
tax rules. Their paper presents estimates of the likely effects of
different recent tax proposals on the timing and magnitude of business
investments in equipment and structures.
A significant alternative to investment in the United States is additional
direct investment in overseas production facilities. The paper by
Michael Boskin and William Gale reports that tax-induced changes in
the net profitability of investment in the United States has an important
effect on the international location of investment, particularly on the
amount of foreign direct investment financed by retained earnings.
More precisely, Boskin and Gale estimate that for every dollar of increase
in U.S. domestic investment induced by tax policy, there is a
reduction of approximately six cents of U. S. direct investment abroad
financed out of overseas retained earnings. In addition, the increase in
U.S. domestic investment includes a significant inflow of direct foreign
investment from abroad.
Several previous studies have indicated that existing tax rules distort
the allocation of capital among different types of investments. These
distortions were a primary reason advanced by the Treasury for its
proposed changes in depreciation rules and for elimination of the investment
tax credit. The present research confirms the existence of
important distortions in investment incentives but indicates that the
nature of the bias in current tax law is quite different from what has
previously been asserted.
More specifically, in contrast to the common assertion that current
tax law factors investment in equipment relative to investment in structures,
the study by Roger Gordon, James Hines, and Lawrence Summers
concludes that current tax rules favor investment in structures
relative to investment in equipment because of the opportunities to
redepreciate buildings that are resold, the differential ability to use debt
to finance investments in structures, and the possibility of arbitrage
between investors in different tax brackets.
Patrie Hendershott's study emphasizes that the important investment
bias in current tax law is not among different components within the
category of business fixed investment but between business fixed investment
as a whole and investments in inventories and in owneroccupied
housing. Current tax rules impose a much higher effective
tax rate on investment in inventories than on investments in business
plant and equipment. Moreover, current tax rules imply a much lower
effective tax rate on investments in owner-occupied housing than on
all forms of business investment. As a result, current tax rules increase
the share of investment going into owner-occ
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