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 effects have reached very different conclusions in spite of a common theoretical framework: the neoclassical growth model with human capital accumulation by infinitely lived households. This paper shows that a model which explicitly specifies human capital accumulation over the life-cycle provides sharper answers. In such a model, a plausible range for the growth effects of eliminating taxes in the U.S. is between 0.5 and 1.3 percentage points compared with zero to four percentage points in the infinitie horizon model. The much wider range found in the literature is due to two assumptions which are commonly viewed as innocuous simplifications but constrast sharply with traditional human capital theory: that households are infinitely lived and face constant point-in-time returns in human capital accumulation. The widely held view that long, finite horizons are closely approximated by infinite horizins us generally invalid. Abstracting from finite horizons leads to a systematic overstatement of the growth effects of taxes. (Copyright: Elsevier)