During the 2000s, economists gained many valuable insights about how taxes affect economic behavior. Drawing on a decade's worth of theoretical models, statistical studies, and observations, this volume is an invaluable guide for policymakers facing important decisions about environmental taxation, marginal tax rates, dividend taxation, and the taxation of business investment.

INTRODUCTION
The U.S. tax system stands at a crossroads, with a number of important policy choices on the horizon. Notably, the 2001 and 2003 tax cuts are scheduled to expire at the end of 2010.

President Obama proposes that the tax cuts be permanently extended for households with incomes below $200,000 ($250,000 for married couples) and that a package of new middle-class tax cuts be adopted. At the same time, he calls for letting most of the Bush tax cuts expire for households with the highest incomes.

These policies will have significant implications for the marginal tax rates on both labor and capital income. President Obama also supports a cap-and-trade program to combat global warming; and he and Congress are moving to adopt tax (and spending) measures to provide fiscal stimulus during the ongoing recession. Finally, the nation continues to face a long-run budget imbalance.

As Congress and President Obama confront these issues, they will need to answer a number of questions. What role can taxes play in setting environmental policy? How do increases in tax rates affect the amount of work people do and the amount of taxable income they report? How are the economic effects of tax cuts altered when they are financed by deficits? How does the tax system affect businesses’ financial and investment decisions?

During the last decade, economists have learned a great deal about these issues, even though much remains uncertain. On May 30, 2008, the American Enterprise Institute gathered a number of scholars to describe what the economics profession has learned during the 2000s about the key tax policy issues now confronting the nation. This volume contains six of those papers, each followed by a discussant’s response. ...

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Editor: Alan D. Viard
The AEI Press
Publisher for the American Enterprise Institute

Alan D. Viard is a resident scholar at the American Enterprise Institute.
Contributors: Alan J. Auerbach, Steven J. Davis, Dhammika Dharmapala, John W. Diamond, Nada Eissa, Daniel Feenberg, Seth H. Giertz, Kevin A. Hassett, Laurence J. Kotlikoff, Gilbert E. Metcalf, Douglas A. Shackelford, Matthew D. Shapiro, Alan D. Viard, and Roberton C. Williams III.

CONTENTS
LIST OF ILLUSTRATIONS xi
INTRODUCTION, Alan D. Viard 1
1. ENVIRONMENTAL TAXATION: WHAT HAVE WE LEARNED IN THIS
DECADE? Gilbert E. Metcalf 7
The U.S. Experience with Environmental Taxes 8
Advances in the Theory 13
Efficiency Considerations of Environmental Taxation 13
Distributional Considerations with Environmental Taxation 17
The New Frontier: Carbon Pricing 21
Conclusion 26
Notes 28
References 31
2. A RESPONSE TO GILBERT E. METCALF, Roberton C. Williams III 35
Environmental Taxes in the United States 35
Lessons for Carbon Policy 37
A Brief Proposal for a U.S. Carbon Policy 41
Notes 43
References 44
3. EVIDENCE ON LABOR SUPPLY AND TAXES, AND IMPLICATIONS
FOR TAX POLICY, Nada Eissa 45
Tax Policy Changes in the 2000s and Their Impact on Labor
Supply Incentives 48
Impact on Labor Supply Incentives 51
A Simple Framework for Evaluating the Impact of Tax Cuts
in the 2000s? 56
Taxes and Labor Supply 61
The Budget Set 61
Identification of Labor Supply and Tax Effects 65
What Do We Know about Taxes and Labor Supply? 68
Male Labor Supply 69
Female Labor Supply 72
Intertemporal Responses 78
Implications for Welfare Evaluation of Tax Reform 80
Conclusions 84
Notes 86
References 87
4. A RESPONSE TO NADA EISSA, Steven J. Davis 92
Micro and Macro Studies of Labor Supply Responses to Taxes 93
Longer-Run and Equilibrium Responses to Taxes 95
Labor Supply Responses on Other Margins 96
Summary 98
Notes 99
References 100
5. THE ELASTICITY OF TAXABLE INCOME: INFLUENCES ON ECONOMIC
EFFICIENCY AND TAX REVENUES, AND IMPLICATIONS FOR TAX
POLICY, Seth H. Giertz 101
Developments in Assessing the Efficiency Implications of
Taxation 102
Developments in ETI Research since 2000 105
Issues That Complicate Estimation 107
Recent ETI Estimates 111
Applying the ETI for Tax Policy 115
Data and Institutional Background 117
Revenue and Efficiency Implications of Expiring Tax
Legislation 122
Marginal Deadweight Loss 126
Laffer Curves 128
Conclusion 130
Notes 132
References 134
6. A RESPONSE TO SETH H. GIERTZ, Daniel Feenberg 137
Mean Reversion 139
Inequality 140
Partial versus General 142
References 144
7. WELFARE AND MACROECONOMIC EFFECTS OF DEFICITFINANCED
TAX CUTS: LESSONS FROM CGE MODELS, 145
John W. Diamond and Alan D. Viard
Background 146
Basic Theory in OLG Models 146
Rationale for CGE Modeling 147
Auerbach-Kotlikoff Results 147
Lessons Learned in the 2000s 149
Model Structure and Calibration 152
Production 153
Individual Behavior 154
Calibration 155
Simulation Results 160
Immediate Spending Offset 161
Government Transfer Offset after Ten Years 165
Across-the-Board Tax Increase after Ten Years 168
Summary of Macroeconomic Effects 172
Intergenerational Welfare Effects 173
How Are Deficit-Financed Tax Cuts Typically Paid For? 176
Models of Infinite-Lived Agents 179
Conclusion and Extensions 181
Appendix 184
The Nonresidential Production Sector 184
The Owner-Occupied and Rental Housing Production Sectors 186
Individual Behavior 187
Notes 189
References 191
8. A RESPONSE TO JOHN W. DIAMOND AND ALAN D. VIARD,
Laurence J. Kotlikoff 194
References 198
9. THE IMPACT OF TAXES ON DIVIDENDS AND CORPORATE FINANCIAL
POLICY: LESSONS FROM THE 2000S, Dhammika Dharmapala 199
Lessons about Dividends, Payout Policy, and Firm Value 202
A Simple Equilibrium Condition 202
The Effects of JGTRRA on Dividends 205
The Effects of JGTRRA on Firm Value 207
Interpreting the Evidence 208
Lessons about Corporate Financial Policy and Portfolio
Choices 210
International Financial Equilibrium 211
The Effect of JGTRRA on U.S. Investors’ Equity Holdings 215
Lessons about Corporate Tax Integration 220
The Efficiency Costs of Corporate Financial Distortions 220
Corporate Tax Integration and International Financial
Integration 221
Future Directions for Dividend Tax Policy 224
Firm-Level Approaches to Corporate Tax Integration 225
Conclusion 226
Notes 227
References 231
10. A RESPONSE TO DHAMMIKA DHARMAPALA, Douglas A. Shackelford 234
Why JGTRRA Might Have Had No Effect on Dividend
Policy 234
Shareholders Not Benefiting from JGTRRA Influence
Dividend Policy 235
Repurchases Remained More Tax-Efficient than Dividends 235
Dividends Were Unpopular 236
Rate Reductions Were Temporary 236
Adjustments Distort Dividend Signaling 237
Increased Dividends Have Adverse Implications for
Stock Options 237
Alternative Minimum Tax Dulls Benefit 237
Summary 238
Nontax Explanations for the Increase in Dividends 238
What We Have Learned from the Extant Studies 239
Great Paper, circa 2013 242
The Forgotten Capital Gains Tax Cut 243
Conclusion 243
Notes 245
References 246
11. TAXES AND BUSINESS INVESTMENT: LESSONS FROM THE
PAST DECADE, Alan J. Auerbach and Kevin A. Hassett 248
Partial Expensing 251
Dividend Taxes 255
The Investment Effect of Dividend Tax Changes 258
Dividend Payout Changes 261
Conclusion 264
Notes 266
References 267
12. A RESPONSE TO ALAN J. AUERBACH AND KEVIN A. HASSETT,
Matthew D. Shapiro 271
Note 278
References 279
INDEX 281
ABOUT THE AUTHORS 291

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