Hassett's Numbers are Plausible
By David Henderson
In the long run, all of the factor owners’ loss from a capital income tax is a loss to labor (the area below the horizontal dashed line is negligible; see A below). Therefore, in the long run, capital-income tax revenue is a LOWER BOUND on labor’s loss. Furman and Summers have it backwards.
This is from Casey Mulligan, “Furman and Summers revoke Summers’ academic work on investment,” October 18, 2017.
This is Casey’s comment and analysis on the current controversy over whether Kevin Hassett’s claim of large increases in wages due to corporate tax cuts make sense.
It’s a technical argument and you might not follow all of it. Here’s one paragraph that might help:
Why would labor bear all of the burden in the long run? Well, ask Larry Summers back when he used to be an academic studying these matters. His 1981 Brookings paper, which even today is an article commonly used by me and others to teach this in graduate school, says so on page 81 equation (7). The left-hand-side of that equation is a perfectly elastic long-run supply of capital: it says that the supply curve in my picture is, in the long run, properly drawn as horizontal. See also Lucas (1990, p. 303, equation 4.3).
But if you don’t know this literature somewhat, the above paragraph might not help you much. So let me explain in simpler words by noting that the key assumption in the above is the assumption of a perfectly elastic long-run supply of capital. Why would it be perfectly elastic? Because capital is quite mobile across countries, so when one country’s government cuts it tax rate on capital, that draws in capital from around the world.
Why does this matter? The greater the stock of capital, the higher is the ratio of capital to labor, and, therefore, the higher is the marginal product of labor, and, finally, the higher is the real wage.
Here’s Mulligan again, with some of the important parts of the technical argument:
Using a Cobb-Douglas aggregate production function with labor share 0.7, and a 50% capital-income tax rate (combining corporate, property, and the capital components of the personal income tax), I get a Furman ratio of 350%. With a 40% tax rate instead, the Furman ratio is 233% (algebra here; these refer to modest tax-rate reductions — not going all of the way to zero).
If the current CEA said 250%, then it got Furman’s ratio much closer than Furman did, who puts it less than 100%.
HT2 Greg Mankiw.