Wednesday, October 8, 2008

Back-of-the-envelope effect of capital taxes

Lee Ohanian provides a look at the possible effects of an increase in the tax on capital proposed by the Obama economic team.

Moving from a 50% marginal tax rate (the sum of a 35% marginal corporate income tax plus the 15% personal income tax rate on capital gains and dividends) to a 55% rate by increasing the overt tax on capital from 15% to 20% is still an increase of 5 percentage points. But relative to the total tax rate, that's an increase of 10%.

The Ramsey model with Cobb-Douglas production and a capital share of 1/3 suggests this would ultimately reduce the level of capital and output along a balanced growth path by 5%, which is nothing to sneeze at.