Abstract: This paper investigates the consequences of changes in the age composition of the population for the mix of tax rates on labour and capital income. The analysis is conducted within a quantitative general equilibrium overlapping-generations model. Tax rates are determined in a Markov equilibrium through sequential voting without commitment. A calibrated version of the model is used to study quantitatively the effects of past and projected demographic shifts in the US. The younger voting-age population in 1990 relative to 1965 can account for the large decline in the relative capital tax rate observed between these two years; the older voting-age population expected in 2025 leads to a sharp increase in capital taxation. These results reflect that the tension between the induced changes in the decisive voter's age and in macroeconomic conditions is resolved in favour of the latter. A younger population results in a higher net private return to capital, causes voters to save more, and leads them to become less supportive of capital taxes. A simple analytical model is provided to articulate the intuition.

The American Economic Review, 100:1, 337-363, 2010 download