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Larry Summers complains to the Wall Street Journal that my op-ed last week used a "highly selective and out-of-context quotation" to "leave the impression that I support his conclusion that capital gains taxes should be eliminated." Sorry, Larry... I wish I'd had room to quote more extensively -- it would have made my case even stronger. From "Capital Taxation and Accumulation in a Life Cycle Growth Model" in The American Economic Review, Vol. 71, No. 4, September, 1981:

This paper reexamines the incidence and welfare consequences of capital income taxes within a realistic life cycle model. The results suggest that the elimination of capital income taxation would have very substantial economic effects. For example, a complete shift to consumption taxation might raise steady-state output by as much as 18 percent, and consumption by 16 percent. The long-run welfare gain from such a shift would for plausible parameter values exceed $150 billion annually. Stated somewhat differently, shifting to consumption taxation would raise the lifetime utility of the representative consumer by the equivalent of about six years' income in the new steady state. These estimates dwarf estimates of the static welfare cost of taxation, and significantly exceed even extreme previous estimates of the dynamic loss.

This study departs from earlier analyses of the effects of taxes on capital income in several respects. Probably the most important difference between this treatment and most preceding ones lies in the assumptions about the interest elasticity of saving. It is shown below that the common two-period formulation of saving decisions yields quite misleading results. A more realistic model of life cycle savings demonstrates that, for a wide variety of plausible parameter values, savings are very interest elastic. Tlus implies that shifting away from capital income taxation would significantly increase capital formation, making possible long-run increases in consumption.

All I want to know is: who is that dwarf he's talking about?

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