A taxation policy toward capital, technology and long-run growth

Incorporating the particular features of the U.S. tax code, notably corporate interest deductions and R&D expensing, into Romer's R&D-based endogenous growth model, we analyze how taxation of different-source capital income affects long-run growth by distorting saving, input demands, and stock market P/E ratios. Surprisingly, we find that a pro-growth tax system requires a lower income tax rate for noninnovative firms, particularly when R&D receives tax credits. Simulations for the U.S. economy provide the effects of taxation on growth, interest rates, P/E ratios, human capital allocations, and welfare.