Quantitative Evaluations of Efficient Tax Policies for Lucas' Supply Side Models.

Robert Lucas's recent paper on supply-side economics (1990) finds a large welfare loss from taxation of interest income in the U.S. economy. The present work extends the analysis of steady-state equilibria to cover the transition paths that accompany tax reform. Calculations then show a 25 percent reduction in taxes on capital's income, instituted through a carefully designed sequence of steps, yielding a 1-1.5 percent welfare gain. The analysis also considers government debt and an investment tax credit. In addition, it reveals a potential problem with one aspect of the model's stability properties, when growth is purely endogenous. Copyright 1995 by Royal Economic Society.