Does the Open Economy Assumption Really Mean That Labor Bears the Burden of a Capital Income Tax?

Jane G Gravelle 1 , 1  and Kent A. Smetters 2 , 2
  • 1 Congressional Research Service, jgravelle@crs.loc.gov
  • 2 The Wharton School, University of Pennsylvania, smetters@wharton.upenn.edu

Abstract

The conventional view holds that domestic labor, not domestic capital, bears most of the long-run burden of a corporate income tax in an open economy due to the ability of capital to move across borders. This result assumes that domestic and foreign products (as well as investments) are perfect substitutes. This paper includes imperfect product substitution within a multi-sector open-economy model, and shows that much of the burden may fall on capital. To be sure, if savings falls sufficiently, much of the burden shifts to labor, but this fact also holds in a closed economy. Hence, the debate about tax incidence must focus more on the savings response and less on whether an economy is open or closed.

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The B.E. Journal of Economic Analysis & Policy (BEJEAP) is an international forum for scholarship that employs microeconomics to analyze issues in business, consumer behavior and public policy. Topics include the interaction of firms, the functioning of markets, the effects of domestic and international policy and the design of organizations and institutions.

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