How Taxes Affect Economic Behavior

By Henry J. Aaron; Joseph A. Pechman | Go to book overview

behavior need to be refined beyond the assertion that households lift corporate and government veils or that corporate and government saving contribute to households' perception of life-cycle resource availability. Until they are so refined, the possibility remains that the statistical offset between corporate saving and taxes on the one hand and personal saving on the other is not behavioral but fronting for something else.

If the government's ability to stimulate personal consumption through tax-transfer measures is as limited as the foregoing evidence suggests, its power to contribute to recovery through conventional fiscal means, such as across-the-board tax changes, should not be exaggerated.67. While higher government purchases would stimulate aggregate demand, the difficulties of varying government expenditures in a timely fashion for countercyclical purposes are well known. Furthermore, the tax net of transfer rates has changed appreciably only within but not between cycles. The policy drama that has surrounded successive tax debates since at least 1964 should not be allowed to obscure the stability of the fiscal policy rule that has been followed implicitly since the end of the Korean War.

Adherence to the rule appears to have contributed to the net private saving rate changing fairly little across cycles to date. This outcome could change if a different fiscal policy were followed persistently in the future. Whether or not a particular component of the national saving rate, or any grouping of the components, remains approximately constant depends heavily on whether expectations regarding traditional fiscal policies can be broken. There is no economic law that says they should not be.


Appendix A: Data Definitions and Notation
CCA Capital consumption adjustment divided by net national
product (NNP)
GS Government saving (surplus or deficit) divided by NNP
IVA Inventory valuation adjustment divided by NNP
____________________
67.
Even though agreeing with Tanner, "Fiscal Policy," p. 319, in this respect, one should realize that tax reductions can stimulate aggregate demand even if they have little or no initial effect on national saving. A rise in the rate of the investment tax credit or any other tax change that affects spending incentives via substitution effects at the margin may increase aggregate demand. The point here is only that income effects alone are unlikely to have much impact and that substitution effects must be aimed at in devising an effective tax reduction (or tax increase) program. In view of the political attraction of voting only for balanced or across-the-board tax cuts, the chances of activating substitution effects are slim unless the conventional pattern can be broken by instituting differential tax changes.

-370-

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