Friday, December 6, 2019
Sungki Hong (Federal Reserve Bank of St. Louis) & Terry S. Moon (University of British Columbia), Capital Gains Taxation and Investment Dynamics:
This paper quantifies the long-run effects of reducing capital gains taxes on aggregate investment. We develop a dynamic general equilibrium model with heterogeneous firms, which face discrete capital gains tax rates based on their firm 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 find that the firm-size reform that reduced the capital gains tax rates from 24 percent to 10 percent for the affected firms increased aggregate investment by 2.6 percent and 1.7 percent in the short-run and in the steady state, respectively. Additionally, in a counterfactual 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 findings 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.