Capital Gains Taxation and Investment Dynamics

Hong, Sungki; Moon, Terry S.

doi:10.20955/wp.2018.031

Working Paper

Capital Gains Taxation and Investment Dynamics

Abstract: This paper quanti?es the long-run effects of reducing capital gains taxes on aggregate investment. We develop a dynamic general equilibrium model with heterogeneous ?rms, which face discrete capital gains tax rates based on their ?rm size. We calibrate our model by targeting relevant micro moments as well as the difference-in-differences estimate of the capital elasticity based on the institutional setting and a policy reform in Korea. We ?nd that the ?rm-size reform that reduced the capital gains tax rates from 24 percent to 10 percent for the affected ?rms increased aggregate investment by 2.6 percent and 1.7 percent in the short-run and in the steady state, respectively. Additionally, in a counter factual analysis where we set the uniformly low tax rate of 10 percent, the aggregate investment rose by 6.8 percent in the long-run. Taken together, our ?ndings suggest that reducing capital gains tax rates would substantially increase investment in the short-term, and accounting for dynamic and general equilibrium responses is important for understanding the aggregate effects of capital gains taxes.

Keywords: Capital; Fiscal Policy; investment decisions; Business Taxes and Subsidies; Saving and Capital Investment;

JEL Classification: E22; E62; G11; H25; O16;

https://doi.org/10.20955/wp.2018.031