Barbara M. Fraumeni Muskie School of Public Service, University of Southern Maine & the National Bureau of Economic Research, USA IARIW, Session 3 Joensuu,

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Barbara M. Fraumeni Muskie School of Public Service, University of Southern Maine & the National Bureau of Economic Research, USA IARIW, Session 3 Joensuu, Finland August 22, 2006 Taxes & the Rate of Return in User Cost Expressions by Kirsten Bonde, Ministry of Economic & Business Affairs, Denmark & Henrik Sorensen, Statistics Denmark

Muskie School of Public Service Ph.D. Program in Public Policy SOURCES OF ECONOMIC GROWTH: DOES IT MAKE A DIFFERENCE?  Tax variables or not?  Exogenous or endogenous rate of growth?

Muskie School of Public Service Ph.D. Program in Public Policy CONCLUSION CALIBRATION MATTERS TAX RATES HAVE LITTLE IMPACT

Muskie School of Public Service Ph.D. Program in Public Policy General Productivity Model  Aggregate production function with K, L, and TFP  Decomposition of labor productivity into K deepening, L quality, and TFP  Emphasis on aggregate production function, but industry production functions also estimated with Domar weights aggregation

Muskie School of Public Service Ph.D. Program in Public Policy User Cost Expressions  Without tax terms  User cost = net return + depreciation rate – capital gain on assets rate  Rate of return depends upon the interest rate on debt and the net rate of return on other capital  With tax terms  Following Jorgenson, Ho, & Stiroh (2002))  User cost above is multiplied by a ratio tax term (see eqn p. 6) and a term with the property- type tax rate is added

Muskie School of Public Service Ph.D. Program in Public Policy Endogenous Rates of Return Calibration  User costs, not labor costs, are controlled  User costs are in general too high with exogenous rates of return  Suspected culprits: service lives and mortality functions  Aside: Statistics Finland used net capital stock, not user costs, in its productivity estimates

Muskie School of Public Service Ph.D. Program in Public Policy Impact of Taxes on K Deepening (with calibration)  Only K deepening (TFP) can change between tax or not tax scenarios  TFP = and opposite change to K deepening  K deepening results mixed as effect of user costs without taxes is strongest in the early periods due to ICT capital, but these stocks are small in the 60’s and 70’s

Muskie School of Public Service Ph.D. Program in Public Policy Impact of Rate of Return (with taxes) Major differences except in the 70’s (Table 4.1, p. 13) ‘66-73‘79-87‘87-93‘93-00 Labor productivity Non-ICT K deepening TFP

Muskie School of Public Service Ph.D. Program in Public Policy Impact of Rate of Return (cont.)  For the period as a whole, , labor productivity only differs by.1  But the decomposition of labor productivity can change significantly by year depending upon calibration or not

Muskie School of Public Service Ph.D. Program in Public Policy Impact of Taxes with an Exogenous ROR  Labor productivity growth rate is in general higher when taxes are included  Effect similar for K deepening and labor  Impact on TFP mixed  However, tax impact remains less than the calibration impact

Muskie School of Public Service Ph.D. Program in Public Policy Industry Results Rate of Return (with taxes)  Fishery and transport show the largest changes in labor productivity  Opposite in sign  Both industries intensively use transport equipment  Much year to year variation in changes  No pattern  Leads to uncertainty in estimates

Muskie School of Public Service Ph.D. Program in Public Policy Industry Results Taxes (with calibration)  Results more or less the same as they were at the aggregate level  For example, labor productivity growth rate is in general higher when taxes are included

Muskie School of Public Service Ph.D. Program in Public Policy Beware!  Rate of return and tax assumptions may differ among countries  Differences in productivity growth between countries may be a result of differences in assumptions, not of actual differences

Muskie School of Public Service Ph.D. Program in Public Policy Comments  Very valuable paper  Methodology & data sources for estimating RORs changed in 1995  ROR after tax is higher than the ROR before tax in some years  How is mixed income handled?  Is K adjusted for quality?