Lecture 4: Toward an Optimal Tax System Part 1: Learning How Taxes Affect the Economy

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Designing an optimal tax system requires a good understanding of how taxes impact the economy, but ideas on how tax policy affects the economy have changed over time.

This session will review the theory and evidence of how taxes impact saving, investment, wages, jobs, output, and income. What has worked, and what has not?

Lecture Highlights

  1. Labor and capital both respond to tax changes, leading to “excise effects” which impact the quantity of inputs and outputs in the economy. Taxes cause “deadweight loss.” Both tax rates and tax bases are important considerations of a tax system.
  2. Demand does not change as taxes change; rather, according to Say’s law, production is the source of demand.
  3. The tax code should be neutral in the way it treats saving and consumption.
  4. Full expensing fixes a bias in the corporate tax code that results in companies being unable to fully deduct the costs of their investments in present-value terms.
  5. Do taxes discourage work or force people to work harder?

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