A theoretical and empirical analysis of the impact of dual income taxation on economic growth

Abstract

Tax systems distort economic behavior in ways that matter for economic growth. It has been argued that a dual income tax reform can alleviate some of these distortions. The dual income tax potentially has influence on output growth through increased allocative efficiency of capital and increased saving and investment. The long run impact of a dual income tax reform is studied in a neoclassical growth model with endogenous labor supply. In this framework, changes in tax rates in line with dual income taxation causes growth in excess of the equilibrium growth rate. The effect of dual income tax systems on economic growth is analyzed empirically by estimating a reduced form macroeconometric relation using aggregate data for a number of OECD-countries. The results are consistent with previous studies in the field. The findings suggest that the dual income tax has had a small positive effect on economic growth. When correcting for data on corporate income taxes this effect is reduced, suggesting a substantial amount of the effect of dual income income taxation on growth is driven by reductions in corporate income taxes.