Implications of Lower Trend Productivity Growth for Tax Policy

Abstract

This paper considers the implications of a sustained period of low productivity growth for the design of tax systems. While the specific changes needed will vary by country and depend on how other features of the economic environment change, several broad conclusions emerge. First, lower productivity growth will exacerbate future fiscal shortfalls associated with aging populations; even assuming that interest rates are also lower, tax systems may need to collect more revenue per dollar of GDP to support their older populations. Second, with lower productivity growth likely to result in lower wages, labor force participation rates may drop further, bolstering the case for more tax incentives for working. Third, the potentially flatter lifetime income profiles associated with lower productivity growth, along with the possibility that fiscal strains will lead to cuts in government retirement benefits, may warrant increasing tax incentives for retirement saving. Finally, the lower real interest rates that would likely accompany sustained low productivity growth may reduce the future efficacy of monetary policy as a macroeconomic stabilization tool, suggesting that countries would be well-served by building more automatic stabilizers into their tax systems.