Corporate Taxation, Capital Formation, and the Substitution Elasticity between Labor and Capital

This study provides some perspective on analyzing the effects of corporate taxation on capital formation. Our framework translates tax policy legislation into real outcomes, and identifies three parameters that play a central role in determining the impact on policy. The remainder of the paper focuses on the substitution elasticity between labor and capital. Several of the prominent studies representing the major contours of this research area over the past 40 years are examined. Our review of five general equilibrium studies indicates that alternative values of this elasticity matter a great deal for the welfare changes following from proposed tax reforms. The paper concludes with two lessons for tax policy analysis and some suggestions for future research.