TAXES AND LONG-RUN ECONOMIC GROWTH: CAN TAX REFORM RAISE “THE SPEED LIMIT” IN DENMARK?

Carl-Johan Dalgaard

NORDIC TAX ECONOMIST MEETING

OCTOBER 1 2012

THREE ISSUES:

• WHAT IS THE MAIN ENGINE OF LONG-RUN GROWTH?

• HOW DOES TAXES AFFECT LONG-RUN GROWTH?

• THOUGHTS ON TAXES AND THE SCOPE FOR A PRODUCTIVITY ACCELERATIONS IN DENMARK

THREE POINTS:

• TOTAL FACTOR PRODUCTIVITY

• FIRM DYNAMICS AND TRANSFER OF IDEAS

• ONE FOCUS AREA: TRADE

WHAT IS THE MAIN ENGINE OF LONG-RUN GROWTH?

GDP PER WORK HOUR

PHYSICAL CAPITAL

HUMAN CAPITAL

(Total Factor) PRODUCTIVITY

Equipment; plants; natural capital

Schooling; health ”Technology”; Public goods

Obviously: Lots and lots of interdependence

QUANTITATIVE IMPORTANCE:

• About 2/3 of economic growth within rich nations is due to (total factor) productivity

• 90% of the differences in growth rates (GDP per employed) across countries is due to TFP

• Unpacking aggregate TFP• Entry/ Exit & Selection of firms. Foundation: New ideas (from

abroad)• Public goods provision (infrastructure; efficient bureaucracy; Public

R&D)

HOW TAXES AFFECT LONG-RUN GROWTH

• Potential direct impact on Total factor productivity

• The ”Dark side” of taxes: Reduces transfer of ideas.• Reduces foreign exposure and affects firm selection (e.g., tariffs). Limits access

and exposure to new ideas.• Reduces the incentive to become (self-) employed (income tax).Introduction of

new ideas; new firms.• Increases the costs of capital (corporate tax; cap gains tax). Introduction of

new ideas embedded in capital equipment• Limits firm exit (subsidies)

• The ”Lighter side” of taxes: What taxes help finance.• Supply of public goods (e.g., infrastructure; bureacratic efficiency; Public R&D)• Insurance: Social security reduces the potential ”downside” from being self-

employed

½

• Theory (e.g., Barro, 1990): Non-linear impact from tax system• Empirics?

Income; property; profits; trade

Defense; health;

education;transport

& comm

unication

• In practise it appears that the net impact from tax and expenditures has been near zero in most OECD countries 1970 -> (Gemmel et al, 2011)

•Bottom line: Composition of taxes (and expenditures) is key

THOUGHTS ON TAXES AND THE SCOPE FOR A PRODUCTIVITY ACCELERATIONS IN DENMARK

• Before we get started … humility

• Two world wars; the demographic transition; the great depression; from agriculture to industry; mass education; stagflation; increasing female labor market participation. 2 percent per annum.

Hourly productivity, Denmark relative to US, 1970-2009.Souece: Penn World Tables 7.0

Hourly productivity: EU G7/USA, 1970-2009 (black); DEU/USA, 1970-2009 (green).Note: (a) G7 is DEU, UK, FRA, ITA. Data: Penn World Tables 7.0.

• Reignite the convergence process. Will admit a temporary growth acceleration.

• Academic literature: Temporary acceleration in growth (10 yrs av). Robust finding: TFP changes; Trade changes (i.e., Imp + Exp / GDP)

• International interaction does spur productivity; influences transfer of ideas and thereby entry/exit and selection

• One focus area: Tariff (and non-tariff) barriers on trade in goods and services

• Suggestive evidence of link between international interaction and growth: Case of Singapore

• Non-tariff Barriers. Francois og Hoekmann on trade restrictions on services (JEL, 2010, p. 662): “…the indexes […] also point to generally higher restrictions in developing countries than in the OECD. At the same time though, some OECD countries (Australia, Canada, and Denmark, for example) have restrictions comparable to the averages prevailing in major developing country economies.” (my emphasis)

• Tariffs. Composition of tariffs (Nunn and Trefler, 2010)

• Bias in tariffs. Positive correlation means ”more protection” of more skill intensive goods

•Source: Nunn og Trefler, 2010, Am. Ec. J. – macro. Note: Growth corrected for impact of investments and human capital . The figure depicts the partial correlation between bias in tariffs and growth.

CONCLUDING REMARKS

• Key importance of TFP; firm dynamics and transfer of knowledge

• Taxes (and expenditures) likely influence this process. Composition of tax and expenditures.

• Productivity accelerations seem to be associated with increased international interaction

• Suggests a focus on tariffs and trade regulation. Structure of tariffs might be more important than levels.

THANK YOU FOR YOUR ATTENTION