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Federal Reserve Bank of St. Louis
Working Papers
Capital Gains Taxation and Investment Dynamics
Sungki Hong
Terry S. Moon
Abstract

This paper quantifies the long-run effects of reducing capital gains taxes on aggregate investment. We develop a dynamic general equilibrium model with heterogeneous firms, which face discrete capital gains tax rates based on their firm size. We calibrate our model by targeting important micro moments as well as the difference-in-differences estimate of the capital elasticity based on our institutional setting in Korea. We find that the firm-size reform that reduced the capital gains tax rates from 24 percent to 10 percent for the affected firms increased aggregate investment by 1.22 percent in the steady state, with the short-run effects overstating the effects by 1.18 percentage points. Additionally, a counterfactual analysis where we set the uniformly low tax rate of 10 percent reveals that aggregate investment rose by 7 percent in the long-run. We also find that general equilibrium effects through prices are substantial in our simulation. Taken together, our findings suggest that reducing capital gains tax rates would substantially increase investment in the short-term, and accounting for dynamic and general equilibrium responses is important for understanding the aggregate effects of capital gains taxes.


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Sungki Hong & Terry S. Moon, Capital Gains Taxation and Investment Dynamics, Federal Reserve Bank of St. Louis, Working Papers 2018-31, 31 Oct 2018.
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Subject headings:
Keywords: Capital; Fiscal Policy; Investment Decisions; Business Taxes and Subsidies; Saving and Capital Investment
DOI: doi.org/10.20955/wp.2018.031
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