Implications of Tax Policy for Innovation and Aggregate Productivity Growth

The quantitative implications of income taxation for innovation and aggregate productivity growth are evaluated in the context of a Schumpeterian model of innovation-led growth. In the model, innovation comes from entrant firms creating new products and from incumbent firms improving own existing products. The model embodies key features of the U.S. government sector: (i) an individual income (labor income, dividends, and capital gains) and (ii) corporate tax; (iii) a consumption tax; and (iv) government purchases. The model is further restricted to fit observations for the post-war U.S. economy. The results suggest that endogenous movements in TFP constitute a quantitatively important channel for the transmission of tax policy to real GDP growth. Endogenous market structure plays a key role in the propagation of tax shocks