Growth, death, and taxes

Recent theories of endogenous growth suggest that changes in tax rates may permanently affect growth. However, attempts to quantify these growth effec ts have reached very different conclusions in spite of a common theoretical framework: the neoclassical growth model with human capital accumulation b y infinitely lived households. This paper shows that a model which explicit ly specifies human capital accumulation over the life-cycle provides sharpe r answers. In such a model, a plausible range for the growth effects of eli minating taxes in the United States is between 0.5 and 1.3 percentage point s compared with 0 to 4 percentage points in the infinite horizon model. The much wider range found in the literature is due to two assumptions which a re commonly viewed as innocuous simplifications but contrast sharply with t raditional human capital theory: that households are infinitely lived and f ace constant point-in-time returns in human capital accumulation. The widel y held view that long, finite horizons are closely approximated by infinite horizons is generally invalid. Abstracting from finite horizons leads to a systematic overstatement of the growth effects of taxes. (C) 2001 Academic Press.