Tax Policy Design with Low Interest Rates
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Interest rates on government debt have fallen in many countries over the last several decades, with markets indicating that rates may stay low well into the future. It is by now well understood that sustained low interest rates can change the nature of long-run fiscal policy choices. In this paper, we examine a related issue: the implications of sustained low interest rates for the structure of tax policy. We show that low interest rates (a) reduce the differences between consumption and income taxes; (b) make wealth taxes less efficient relative to capital income taxes, at given rates of tax; (c) reduce the value of firm-level investment incentives, and (d) substantially raise the valuation of benefits of carbon abatement policies relative to their costs.
The authors thank Donald Marron, Robert Moffitt, Adele Morris, Joe Shapiro, Louise Sheiner, Reed Walker, and participants in the 2021 WEAI annual conference and 2021 Tax Policy and the Economy conference for helpful comments, and Zachary Babat and Swati Joshi for outstanding research assistance. Gale thanks Arnold Ventures for generous research support. The views expressed here are solely those of the authors and should not be attributed to any other person or any organization.