William B. Peterman

An Extensive Look at Taxes: How Does Endogenous Retirement Affect Optimal Taxation?

This paper considers the impact on optimal tax policy of including endogenously determined retirement in a life cycle model. Allowing individuals to determine when they retire causes the optimal tax on capital to increase by 75% because of two implicit changes in the aggregate labor supply elasticity. First, including endogenous retirement causes an increase in the overall aggregate labor supply elasticity since agents can change their labor supply on both the intensive and extensive margins. In response, the government limits the distortions from the tax policy by lowering the tax on labor and increases the tax on capital. Second, given that the choice to retire is more relevant for older individuals, endogenous retirement disproportionately increases older agents elasticity compared to younger individuals. Ideally, the government would decrease the relative labor income tax on individuals when they are older and supply labor more elastically. However, in the absence of age-dependent taxes, the government mimics such a tax policy by further increasing the tax on capital. I find that the welfare lost from not accounting for endogenous retirement when solving for the optimal tax policy is equivalent to approximately one percent of lifetime consumption.

Taxing Capital? The Importance of How Human Capital is Accumulated

This paper considers the impact of how human capital is accumulated on optimal capital tax policy in a life cycle model. In particular, it compares the optimal capital tax when human capital is accumulated exogenously, endogenously through learning-by-doing, and endogenously through learning-or-doing. Previous work demonstrates that in a simple two generation life cycle model with exogenous human capital accumulation, if the utility function is separable and homothetic in each consumption and labor, then the government has no motive to condition taxes on age or tax capital. In contrast, this paper demonstrates analytically that adding either form of endogenous human capital accumulation creates a motive for the government to use age-dependent labor income taxes. Moreover, if the government cannot condition taxes on age, then a capital tax can be optimal in order to mimic such taxes. This paper quantitatively explores the strength of this channel and finds that, including human capital accumulation with learning-by-doing, as opposed to exogenously, causes the optimal capital tax to increase by between 7.3 and 14.5 percentage points. In contrast, introducing learning-or-doing causes a much smaller increase in the optimal capital tax of between 0.7 and 3.7 percentage points. Taken as a whole, this paper finds that the specific formulation by which human capital is accumulated can have notable implications on the optimal capital tax.

Fiscal Policy and Aggregate Demand in the U.S. Before, During and Following the Great Recession

We examine the effect of federal and subnational fiscal policy on aggregate demand in the U.S. by introducing the fiscal effect (FE) measure. FE can be decomposed into three components. Discretionary FE quantifies the effect of discretionary or legislated policy changes on aggregate demand. Cyclical FE captures the effect of the automatic stabilizers--changes in government taxes and spending arising from the business cycle. Residual FE measures the effect of all changes in government revenues and outlays which cannot be categorized as either discretionary or cyclical; for example, it captures the effect of the secular increase in entitlement program spending due to the aging of the population. We use FE to examine the contribution of fiscal policy to growth in real GDP over the course of the Great Recession and current expansion. We compare this contribution to the contributions to growth in aggregate demand made by fiscal policy over past business cycles. In doing so, we highlight that the relatively strong support of government policy to GDP growth during the Great Recession was followed by a historically weak contribution over the course of the current expansion.