Savings and Taxation

In section 1.2 we shall examine the optimal taxation of capital and labor incomes in a simple growth model and derive formulae for the optimal tax rates. These are used in section 1.3 to evaluate claims that abolishing capital income taxes would lead to large welfare gains. Inflation is introduced in section 1.4, and alternative approaches to modeling savings behavior are discussed in section 1.5. Finally, we shall look briefly at some of the empirical evidence on the effects of taxes on savings. Our analysis will be highly simplified. We shall ignore many of the issues stressed by the Meade Committee, such as the complex interaction between personal and corporate taxation, the sheer diversity of tax rates currently imposed on different forms of saving, and the portfolio aspects of personal saving. The relationship between expenditure on durables and saving and the effect of social security on consumption will also be left to one side, and we shall say little about the production side of the economy. (For surveys of the effects of taxes on investment, see Helliwell, 1976; King, 1977; and von Furstenberg and Malkiel, 1977.) Despite these omissions the model captures the essential features necessary to an evaluation of the efficiency arguments.