New Study: Tax reform will attract $11 trillion in offshore capital

Laurence Kotlikoff and his colleagues have produced a new study of how corporate tax changes affect international capital flows. It uses UN demographic data and IMF fiscal data to estimate output, wages and the capital stock for every major country in the world, extending to the end of the century. The model has more than 3 million equations.

The study provides the most convincing evidence to date that the burden of corporate income taxation is born by labor, not capital. Thus, a cash flow tax with a labor carve out, such as proposed by the House Republicans, is actually quite progressive. It replaces a tax on labor with a tax on wealth. In fact, the economists find that the entire House GOP proposal (corporate plus individual income tax reform) has very little impact on the overall distribution of consumption across income groups. See Goodman Institute backgrounders on the Kotlikoff/Auerbach approach to analyzing fiscal policy and their approach to measuring inequality.

A summary.

A New and Better Way to Analyze Tax and Spending Policies:
1. The standard economic model of fiscal policy, including demographics, saving and economic growth, is the life-cycle model. It was developed in a two-period framework in the 1920s by Yale University’s Irving Fisher. Two periods means that people are young for one period and old for another. When they are young they tend to accumulate assets and when they are old they tend to divest them. Prior to the 1980s, the two-period model reigned supreme

Laurence Kotlikoff and Alan Auerbach cut the Gordian knot of life-cycle modeling in the late 70s by using what is known as the Gauss-Seidel iteration technique. The method permits the study of the dynamic transition paths of large-scale, life-cycle behavior. Their breakthrough permitted economists all over the world to produce their own versions of what is now known as the Auerbach-Kotlikoff model.

However, this is not a feature of private-sector models we are aware of, including the Brookings/Urban Institute Tax Policy Center model and the Tax Foundation model. Failure to incorporate the changing age structure of the population when making long-range estimates leads to serious forecasting errors.
2. International Capital Flows Model. It is well known that capital moves around the world both electronically and physically and it tends to go where it is best treated, other things remaining the same.
3. Corporate Income Taxation Model. Economists have long suspected that the burden of the corporate income tax mainly falls on workers rather than owners of capital or consumers. But the main effect of corporate income taxes, both here and abroad, is to affect the flow of capital. And without a model of international capital flows, there could be no reliable way to analyze the impact of the US corporate income tax. As a result, we now know that the burden of the corporate income tax mainly falls on workers and the elimination of the tax or the substitution of a “corporate flat tax” will result in a substantial increase in wages.
4. The Fiscal Analyser. Developed by Kotlikoff through his company) to understand how much households will spend over their lifetime given their wealth, future labor earnings, future taxes, and future government benefits.

5. Inequality Studies. Although inequality of income and wealth was the single most popular topic at the last meeting of the American Economic Association, there is no way to properly evaluate wealth differences without a life-cycle model. Otherwise, you end up comparing the economic status of people at the beginning of their work lives with people at the peak of their careers and the status of people of working age with people who are retired. Also, you cannot properly evaluate people’s economic wellbeing without including entitlement programs. A 60 year-old couple – both having paid the maximum FICA tax over their work
lives – for example, has more than $1.5 million in Social Security wealth.

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