The role of capital taxation on the business cycle: the case of Chile, 1960–2019

Abstract

How relevant could capital income tax be as a growth engine? We analyse the Chilean experience that since the mid-80s has shown significant increase in its growth rate, outperforming most Latin American countries in the same period. This paper analyses the contribution of capital stock to the Chilean business cycle from 1960 to 2019. We do so by constructing a dynamic general equilibrium model in which firms accumulate capital and capital income taxation occurs at both firm and individual levels. In line with previous studies, we find that productivity shocks were an important driver of growth but unlike them, we find that capital income taxation policies also played an important role in explaining the Chilean miracle. The large adjustments in capital stock that Chile experienced are in line with the reasoning that interest rates in small open economies like Chile respond less to increases in capital taxation, and therefore do not diminish the impact of tax reforms.