What do Aggregate Consumption Euler Equations Say about the Capital Income Tax Burden?

Aggregate consumption Euler equations fit financial asset return data poorly. But they fit the return on the capital stock well, which leads us to three empirical findings relating to the capital income tax burden. First, capital taxation drives a wedge between consumption growth and the expected pre-tax capital return. Second, capital taxation is the major distortion in the capital market, in the sense that most of the medium and long run deviations between expected consumption growth and the expected pre-tax capital return are associated with capital taxation. Third, consumption growth appears to be pretty elastic to the after-tax capital return (i.e., capital is elastically supplied), even while it appears inelastic to returns on various financial assets. Capital income taxes are passed on through reduced capital accumulation, or higher markups, or some combination.

The return to capital and the business cycle

Real business cycle models have difficulty replicating the volatility of S&P 500 returns. This fact should not be surprising since real business cycle theory suggests that the return to capital should be measured by the return to aggregate market capital, not stock market returns. We construct a quarterly time series of the after-tax return to business capital. Its volatility is considerably smaller than that of S&P 500 returns. Our benchmark model captures almost 40 percent of the volatility in the return to capital (relative to the volatility of output). We consider several departures from the benchmark model; the most promising is one with higher risk aversion, which captures over 60 percent of the relative volatility in the return to capital.Business cycles ; Capital

The Case For Investing in Bonds During Retirement

For households seeking retirement income security, short-term deposits (such as money market accounts, certificates of deposit, and Treasury bills) seem an ideal and appropriate investment choice – particularly given the recent extraordinary turbulence in the financial markets. Over the past year, an investment in short-term deposits would have actually outperformed investments in corporate bonds and far outperformed corporate stocks. Retired households exhibit a strong preference for holding such apparently safe investments. One study found that 86 percent of households nearing retirement (ages 60-64) had bank accounts, while only 33 percent owned stocks directly and only 7 percent owned bonds directly. And the desire for short-term investments increased with age. But short-term investments, while safe, produce uncertain returns. This Issue in Brief highlights the trade-off that households must make between a guaranteed return of capital and a guaranteed return on capital – they cannot have both at the same time. Short-term deposits provide a guaranteed return of capital, but offer no guarantees as to the return the household will receive on its capital. In contrast, a portfolio of Treasury bonds of appropriate maturities provides a guaranteed return on capital, but with the return of capital guaranteed only at maturity. This brief argues that retired households seeking a secure and dependable income should prioritize return on capital over return of capital. For such households, the true risk-free asset is a portfolio of bonds and, in particular, inflation-protected bonds of appropriate maturities.

Human Capital, Fertility, and Economic Growth

Our model of growth departs from both the Malthusian and neoclassical approaches by including investments in human capital. We assume, crucially, that rates of return on human capital investments rise, rather than, decline, as the stock of human capital increases, until the stock becomes large. This arises because the education sector uses human capital note intensively than either the capital producing sector of the goods producing sector. This produces multiple steady scares: an undeveloped steady stare with little human capital, low rates of return on human capital investments and high fertility, and a developed steady stats with higher rates of return a large, and, perhaps, growing stock of human capital and low fertility. Multiple steady states mean that history and luck are critical determinants of a country's growth experience.

A Theory of the Supply of Inside Money

This paper advances a theory of the supply of inside money that is squarely based on optimisation, and which sets out from the question, 'As outside money has an opportunity cost that a mere promise to pay outside money does not, why is outside money used at all?'. The theory identifies the nominal rate of return on capital as the key determinant of the supply of inside money. So just as the nominal rate of return on capital is the cost of demanding money, so the nominal rate of return is identified here as the reward for supplying (inside) money. And just as the demand for money is negatively related to the nominal rate of return on capital, so the supply of inside money is positively related to the nominal rate of return on capital.

Can A Draft Induce More Human Capital Investment in the Military?

We consider the possibility a draft increases the likelihood individuals will invest in human capital in the military. This possibility exists because those drafted have less time to reap the return from human capital investment. A draft is more likely to increase human capital investment in the military the larger the civilian return to human capital investment, the shorter the additional time one must spend in the military if one invests while enlisted, and the larger the cost to an individual of obtaining a deferment. Key Words: Conscription, volunteer military, and human capital

The social rate of return on infrastructure investments

The authors estimate social rates of return to electricity-generating capacity and paved roads, relative to the return on general capital, by examining the effect on aggregate output and comparing that effect with the costs of construction. They find that both types of infrastructure capital are highly complementary with other physical capital and human capital, but have rapidly diminishing returns if increased in isolation. The complementarities on the one hand, and diminishing returns on the other, point to the existence of an optimal mix of capital inputs, making it very easy for a country to have too much - or too little - infrastructure. For policy purposes, the authors compare the rate of return for investing in infrastructure with the estimated rate of return to capital. The strong complementarity between physical and human capital, and the lower prices of investment goods in industrial economies, means that the rate of return to capital as a whole is just as high in rich countries as in the poorest countries but is highest in the middle-income (per capita) countries. In most countries the rates of return to both electricity-generating capacity and paved roads are on a par with, or lower than, rates of return on other forms of capital. But in a few countries there is evidence of acute shortages of electricity-generating capacity and paved roads and, therefore, excess returns to infrastructure investment. Excess returns are evidence of suboptimal investment that, in the case of paved roads, appears to follow a period of sustained economic growth during which road-building stocks have lagged behind investments in other types of capital. This effect is accentuated by the fact that the relative costs of road construction are lower in middle-income countries than in poorer and richer countries. As a rule, a tendency to infrastructure shortages - signaled by higher social rates of return to paved roads or electricity-generating capacity than to other forms of capital - is symptomatic of certain income classes of developing countries: electricity capacity in the poorest, paved roads in the middle-income group. To the extent that such high rates of return are not detected by microeconomic cost-benefit analysis, they suggest macroeconomic externalities associated with infrastructure.Decentralization,Banks&Banking Reform,Fiscal&Monetary Policy,Economic Theory&Research,Environmental Economics&Policies,Economic Theory&Research,Banks&Banking Reform,Environmental Economics&Policies,Public Sector Economics&Finance,Inequality

"Unwarranted" Wage Changes and the Return on Capital

Casual empiricism suggests that “unwarranted” wage changes, defined as the part of wage growth that is not explained by changes in labour productivity, are negatively associated with the return on capital. The main point of this paper is to show that “unwarranted” wage changes have no causal effect on capital return. To this end, we show that standard theoretical models, in which “unwarranted” wages changes and the return on capital are endogenously determined, do not necessarily predict a negative association between them. We then estimate aggregate net return on capital equations using panel data for 19 OECD countries for the period 1970-2000 in which we account for the endogeneity of “unwarranted” wage changes by exploiting variations in institutional and labour market characteristics. We find that “unwarranted” wage changes do not affect the return on capital. This result remains robust to alternative empirical specifications and to alternative definitions of profitability and “unwarranted” wage changes. An implication of our findings is that standard calls for reforms aiming at wage moderation following the appearance of “unwarranted” wage changes are not always justified.capital return, profits, “unwarranted” wages, productivity, endogeneity

The Capital Asset Pricing Model: An Application on the Efficiency of Financing Higher Public Education in Egypt

In the Markowitz (1952) mean-variance model as well as the Capital Asset Pricing Model of Sharpe (1964) and Lintner (1965) agents make their investment decisions based solely on the expected return and variance. On the other hand, human capital theory does not consider uncertainty in its return function except recently initiated by Harmon et al. (2001) who distinguish between the level and the years of education and incorporate uncertainty in Mincer’s Model (1974). This study has twofold objectives: First, estimate the risk-return trade-off of the public higher education capital stock in Egypt to indirectly evaluate the performance of its current financing system, and second, investigate the inter-linkage between real investment (human) and financial investment (lost opportunity or access to funds), then draw the channel through which they can affect the economic growth.Human capital investment, financial capital investment, capital asset pricing model

The Return to Capital in Ghana

We show that the real return to capital in Ghana's informal sector is high. For farmers, we find annual returns ranging from 205-350% in the new technology of pineapple cultivation, and 30-50% in well-established food crop cultivation. We also examine the relative prices of durable goods of varying durability, and estimate a lower bound to the opportunity cost of capital of 60%.Capital, durable goods, credit markets