Discussion of “General-Equilibrium Effects of Investment Tax Incentives” by R. Edge and J. Rudd...
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Transcript of Discussion of “General-Equilibrium Effects of Investment Tax Incentives” by R. Edge and J. Rudd...
Discussion of “General-Equilibrium
Effects of Investment Tax Incentives” by
R. Edge and J. Rudd
Roland Straub European Central Bank
Rome, 30 June 2009
Summary of the Paper
Assessing the effect of changes in investment tax policy on capital spending and macro aggregates Partial expensing allowance vs. capital tax rate
“Good and bad news” delivered in the paper: Goods news: under “realistic” nominal rigidities
the impact of partial expensing allowances on investment is stronger than previously contemplated
Bad news: countercyclical fiscal rule with temporary partial expensing can be destabilizing
Framework
Prototype New Keynesian DSGE model with nominal taxation Utility and profit maximisation
Capital accumulation: investment and capital adjustment costs
Sticky prices and wages
Nominal tax on capital and personal income
Balance budget rule: (distortionary) tax income is redistributed (lump-sum) among households
Taylor-style monetary policy rule
Partial Expensing Allowance
Budget constraint of households:
Partial Expensing Allowance: partial rebate of the purchase price of new capital good.
Previously expensed allowance does not receive depreciation allowance.
Good News Partial vs. General Equilibrium Model (flex
price model) DSGE model: flexible price model
Partial model: Tobin’s Q set-up
Capital and Investment adjustment cost
Permanent introduction of (real) partial expensing allowance: Partial equilibrium: only restriction to reach new
equilibrium is due to capital/ investment adjustment cost
GE framework implies a trade-off between capital accumulation and (indirectly) labour supply
Temporary introduction of (real) partial expensing allowance: pulling forward investment
Good News Adding realistic nominal rigidities: sticky prices and
wages, nominal tax system Investment response is stronger than in the flexible price GE and
PE case
Driven by the assumption of sticky wages and unindexed nominal tax system
Sticky wages makes AS curve flatter – investment response is stronger to changes in fiscal policy
Unindexed nominal tax system: investment is a function of nominal interest rates – lower inflation rate further stimulates investment by inducing lower nominal ineterest rates.
Expansionary fiscal policy can also push down inflation (see also Straub and Tchakarov, 2006 for government investment)
Bad News Countercyclical Investment tax is destabilising
Christiano (1984): anticipation of the introduction of partial expense allowance is destabilising
Investment decision are postponed
Further weakening investment in the run-up of the enactment of the expensing allowance
Still partly true in this model, but is partly offset by the desire to avoid large swings in capital stock and investment spending due to adjustment costs.
Partial Expensing vs. Capital Income Tax cuts
Impact of capital income tax cuts are frontloaded Best “tax-savings strategy” for an individual firm is to purchase
and hold capital right at the beginning and hold it until the end.
Expense allowance is worth roughly the same at any point of the allowance period.
Partial Expensing has a stronger revenue impact
Capital income tax cuts are fiscally expensive: Capital income tax applies income to all capital while expensing
allowance applies only to new investment
Some Remarks and Suggestions
Fiscal Policy (partial expensing allowance) as a countercyclical tool
Normative issues
Investment tax and the open economy
Distributional issues
Comments : Fiscal Policy as a Countercyclical Tool
Under which circumstance are investment tax incentives the best tool?
The paper provides an interesting overview of the advantages of partial expense allowance compared to other fiscal instruments
Comments : Fiscal Policy as a Countercyclical Tool
Investment based tax incentives have some appeal compare to other fiscal measures
Income taxes, in general, stimulate the least when they are expected to be temporary, but permanent income tax cuts might jeopardize budget discipline (Laffer-curve)
Government consumption may face constraints in the existence of Ricardian Equivalence
Government investment might have some appeal, but require that government decides about the “sensibility” of investment projects – long time lag
Comments : The role of credit constraint
What is the scope of investment tax incentives for the current crisis?
Investment tax incentives might not work if credit market are distorted (as currently) Investment will not be responsive to changes in
the intertemporal price due to credit constraints
Important to identify the reason for the downturn to assess the efficiency of the instrument
Important to check for the role of credit constraints
Comments : Normative issues
What is the goal of fiscal policy in the model? Metric (seems to be): (i) maximum response of
investment/ output, (ii) fiscal efficiency
Metric could be spelled out more clearly
Possibly, but not necessarily based on micro-founded welfare
Comments: What is the goal of fiscal policy? Temporary investment tax incentives in an open
economy Investment tax incentives might have substantial impact
on the trade balance
Alternative policies can have differential impact on the external positions
Temporary investment tax incentives might have consequences on income distribution Major differences in the response of asset holders and
non-asset holders
To check some of the hypothesis, I utilise the open-economy version of the NAWM (Coenen and Straub, 2005)
New Area Wide Model
Two-country Open Economy Model (Coenen and Straub, 2005) Calibrated to match US and euro area macro data
New Keynesian DSGE Model
Real rigidities: monopolistic competition, investment adjustment costs, variable capacity utilisation
Nominal Price and wage rigidities
Open Economy: consumption and investment imported goods, producer currency pricing.
New Area Wide Model
Two-country Open Economy Model (Coenen and Straub, 2005) Heterogeneous Households: asset holders (HH I)
and non-asset holders (HH J).
Fiscal Policy: government consumption, government investment, distortionary taxes (consumption, capital, income).
A fall in distortionary taxes are matched by am asymmetric reduction of lump-sum transfers.
Open Economy Issues: Capital Tax Shock
0 5 10 150
0.02
0.04
0.06Output
0 5 10 150
0.05
0.1Capital Stock
0 5 10 15-0.01
-0.005
0
0.005
0.01Consumption
0 5 10 150
0.1
0.2
0.3
0.4Investment
One percent capital tax cut
0 5 10 150
0.05
0.1
0.15
0.2Imports
0 5 10 150
0.02
0.04
0.06Exports
0 5 10 15-0.03
-0.02
-0.01
0
0.01Trade Balance
0 5 10 15-0.02
0
0.02
0.04
0.06Terms of Trade
Triggering a trade balance deficit
Open Economy Issues: Capital Tax Shock
Open Economy Issues: Income Tax Shock
0 5 10 150
0.1
0.2
0.3
0.4
0.5Output
0 5 10 150
0.05
0.1
0.15
0.2Capital Stock
0 5 10 150
0.1
0.2
0.3
0.4Consumption
0 5 10 150
0.2
0.4
0.6
0.8Investment
One percent income tax cut
0 5 10 150
0.05
0.1
0.15
0.2Imports
0 5 10 150
0.5
1
1.5Exports
0 5 10 15-0.05
0
0.05
0.1
0.15Trade Balance
0 5 10 150
0.2
0.4
0.6
0.8Terms of Trade
Open Economy Issues: Income Tax Shock Triggering a trade balance surplus
Distributional Issues: Capital Tax Shock
0 5 10 150
0.02
0.04
0.06
0.08
0.1Hours Worked
0 5 10 150
2
4
6
8x 10
-3 Real Wage
0 5 10 150
0.005
0.01Consumption: HH I
0 5 10 15-0.08
-0.06
-0.04
-0.02
0Consumption: HH J
Negative correlation of consumption of HH I and J
Distributional Issues: Capital Tax Shock
0 5 10 15-0.02
0
0.02
0.04
0.06
0.08Hours Worked: HH I
0 5 10 150
0.05
0.1
0.15
0.2Hours Worked: HH J
0 5 10 150
0.005
0.01
0.015Real Wage: HH I
0 5 10 15-1
0
1
2
3x 10
-3Real Wage: HH J
Mainly driven by a fall in transfers to HH J
Distributional Issues: Income Tax Shock
0 5 10 150
0.2
0.4
0.6
0.8Hours Worked
0 5 10 15-0.4
-0.3
-0.2
-0.1
0Real Wage
0 5 10 150
0.1
0.2
0.3
0.4Consumption: HH I
0 5 10 150
0.5
1
1.5Consumption: HH J
Positive correlation of consumption of HH I and J
Distributional Issues: Income Tax Shock Similar path of labour effort and real wages of HH I and J
0 5 10 150
0.2
0.4
0.6
0.8Hours Worked: HH I
0 5 10 150
0.2
0.4
0.6
0.8Hours Worked: HH J
0 5 10 15-0.4
-0.3
-0.2
-0.1
0Real Wage: HH I
0 5 10 15-0.4
-0.3
-0.2
-0.1
0Real Wage: HH J
Conclusion Very interesting paper
It is very timely and relevant to think about the macro effects of fiscal policy beyond government spending
Credit constraints and investment tax incentives
What is the right metric for a normative approach?
Open Economy issues
Distributional issues