International effects of corporate tax cuts on income distribution

Abstract

In late December 2017, the United States slashed its corporate income tax rate (CIT) and became the latest example of a downward trend across OECD countries since the early 1980s (see Figure 1). 1 The passage of this CIT cut has rekindled the debate over who stands to benefit from it and whether such a type of tax cuts exacerbates income inequality. 2 While a large body of literature has focused on the burden of CIT on factors of production (i.e., capital and labor), studies that assess the cross-border impacts of national CIT cuts on income inequality have been few and far between. 3 This paper contributes to such a debate by presenting a multi-country DSGE model with heterogeneous agents to explore the effects of a unilateral CIT cut on domestic income inequality and, the often overlooked, international spillover effects. In particular, the model provides a mechanism by which a CIT cut increases income inequality, domestically and internationally, and examines how such increases are driven over the short and long runs. Our model consists of "capitalist" households, who own capital, and "worker" households whose income consists exclusively of labor income. Our model

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“…Naturally, a similar condition applies to the equality between the value marginal product of capital and its rental rate, R, multiplied by μ. 3 As we will see, the robust cost-minimization conditions alone allow us to measure the extent of a firm's market power, even though they do not by themselves answer the interesting question of why the firm has market power. Thus, the firm optimality condition above holds regardless of the form of imperfect competition that generates the markup.…”

“…The fundamental condition arising from profit maximization is that the firm equates the marginal product of labor valued at marginal cost to the wage. The equation in the text follows from observing that marginal cost by definition equals the ratio of the output price to the markup, which is itself price over marginal cost 3. This cost-minimization condition holds even if it is costly for the firm to adjust its capital stock.…”

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“…Put another way, the difference between the change in revenue and the change in burden is equal to the change in the tax system's deadweight loss-the change in tax burden over and above revenue raised. 2 If a tax cut resulted in a substantial increase in the tax base, as was argued by many of those supporting the 2017 corporate tax changes, then the measured impact on wages would be quite a bit larger if based on the net change in revenue rather than on the change in revenue holding the tax base fixed. 3 A third point to keep in mind is that constructing distributional estimates implicitly requires filling in important details not provided in the legislation.…”

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