INCREASING THE CAPITAL INCOME-TAX MAY LEAD TO FASTER GROWTH

According to conventional economic wisdom, capital income taxes should be low. The purpose of this paper is to cast doubt on this general co nclusion and to show that theory can also point in the opposite direct ion. The paper shows that under rather mild conditions, higher capital income taxes lead to faster growth in an overlapping generations econ omy with endogenous growth. Government expenditures are fixed as a fra ction of GNP and are financed with labor income taxes as well as capit al income taxes. Since capital income accrues to the old, taxing it re liefs the tax burden on the young and leaves them with more income out of which to save. The net effect on savings is positive, if the inter est elasticity of savings is sufficiently low, which it seems to be ac cording to several estimates found in the literature. The basic argume nt is not seriously challenged by a grandfather clause for initial cap ital or by the old receiving some labor income as well. Extending the model to allow for multiple periods of lives, however, can overturn ou r results and support the conventional wisdom instead.