Tax Policy, the Interest Elasticity of Saving, and Capital Accumulation: Numerical Analysis of Theoretical Models

Research methodology is increasingly turning to simulation analysis based on theoretical models and assumed parameter values. The impact on saving and wealth of an increase in the aftertax rate of return to saving, generated by a cut in the tax rate on income from capital, is analyzed in a theoretical simulation context. The consequences of reduction or elimination of taxation of capital income taxes are examined in a general equilibrium context. The life cycle of household saving is shown to be consistent with values for the interest elasticity of saving ranging from close to zero, to very large. When intergenerational transfers are introduced, negative interest elasticities of saving become entirely plausible. The major methodological implication is that simulation of theoretical models based on assumed parameters may be better suited for illustrative purposes than in attempts to provide clear cut results.