Assignment:
Congress frequently considers proposals to reduce the rate at which capital gains are taxed (i.e. lowering the costs of capital). Proponents believe that the reduced capital gains tax rate would encourage businesses to expand and hire more workers. Opponents argue that such a tax cut would primarily benefits stockholders. Although it is an important aspect of the debate, for the purposes of this question, you may ignore the effects that the proposed tax cut would have on the federal governments budget deficit.
1) Do proponents of the capital gains tax cut believe that labor and capital are gross complements or gross substitutes? What do opponents believe about the magnitudes of the substition and scale effects? Support your answer with a graph.
2) What does the empirical evidence suggest about these claims? Based on that evidence, which group of workers are more likely to see their wages rise following a capital gains tax cut? Which groups are most likely to experience wage declines and/or layoffs?
3) An alternate policy to encourage employment involves cutting payroll taxes (e.g. those that fund Social Security). Doing so would result in lower labor costs for firms, i.e. you can see it as if the wage declines. If we continue to ignore any effects on the federal budget, can we say for sure whether a payroll tax cut would increase employment in the long run? Why or why not?
4) Regardless of your answer to part (c), assume now that the payroll tax cut would increase employment. Would the employment increase more in the short run or the long run? Why?