I am working on my paper on household production over the business cycle (although seems weird to call this one a "cycle" since we're just kind of puttering along in the trough), reading Greenwood and Hercowitz's 1991 JPE paper "The Allocation of Capital and Time Over the Business Cycle", and I came across this interesting point (when they mention "household capital" they're refering to both residential investment and also consumer durables which are inputs to household production):
"Another problem with the perfect substitution assumption arises
when taxation of market activity is considered. Although both capital
stocks are subject to property taxes, only business capital is subject to
income taxation, which is far from being trivial (see Jorgenson and
Yun 1986). This creates a significant distortion favoring the accumulation
of household capital at the expense of business capital. This
feature of the tax system, which is incorporated in the current analysis,
is likely to be important for modeling the behavior of business
and household investment. In a model with perfect substitution between
the two capital stocks, business capital would be driven to zero."
This is paper - which talks a lot about household capital - is less important for me than another in the same issue by Benhabib, Rogerson, and Wright, which focuses more on home production and labor supply. But it was an interesting point.
All of these are RBC models. The RBC guys have definitely done the most work incorporating household production into macro.
Sunday, November 11, 2012
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From what you've reading, how much of it is theoretical? I haven't read anything on the topic, so I apologize if this is way off the market; but, how much of it is theoretical and depends on rational expectations?
ReplyDelete(I didn't read the article, but I glanced at it: it seems to me that what was happening in the 1970s was different from what happens during "demand shock" recessions.)
When you say traditional household production: I think you mean keeping production in the home rather than in the market; doing the wash rather than going to the dry cleaner. At first, I thought you meant with respect to gender roles.
ReplyDeleteRight, in regard to this point I mean the former. Of course that usually comes with the latter and for that reason I definitely had the latter in mind too.
DeleteI disagree. It just diverts production from business to households. Instead of laundromats we have home washer and dryers, but we have many more of them and larger business capital investments in producing them. It is the conversion of a service into a product but the product needs more production than the service. Instead of taxing the laundromats income over time we tax the manufacturers up front. Household services aren't taxed because they do not generate income. If you impute income you would also have to impute the capital deduction making this a wash. Now income taxes do shift labor from business to households where it is not taxed, but it does that regardless of capital. It also supports the investment of household capital to reduce that labor, but that increases business capital in producing these products while decreasing the amount of business services produced.
ReplyDelete"It just diverts production from business to households."
DeleteYou're assuming that the two cases face the same trade-offs. That is not likely to be the case. A laundromat may be able to take advantage of certain process and technological improvements that a household process can't. if that's true then we have a distortion and more capital investment is going into an area with a lower rate of return than an alternative.
"Household services aren't taxed because they do not generate income."
They don't generate pecuniary income, but they do generate a non-pecuinary return. When I bring together washing powder, time and a washing machine to wash my clothes that benefits me. The output I want is clean clothes, the consumer goods I use are a means to that end. So, if you imputed this non-pecuinary income it would not be equal to capital deductions.
I agree entirely with you're last two sentences though.
I think the opposite is more likely the case. Laundromats would be smaller more intensive markets while home would be larger and more diverse. The laundromat wants extremely reliable heavy duty long lived machines while the home wants extremely diverse options, lighter duty and shorter lived demanding more advanced features and the larger market means more specialization is possible to cater to consumer tastes. I agree there is more value in the form of convenience, flexibility, and transport in doing it at home but there is no capital income difference as you would pay for the machines incrementally in one case and at once in the other and that is income to the laundromat or manufacturer. In the case of the laundromat that is passed along to the manufacturer as they would be a capital deduction. The increase in home production capital may offer a lower financial return, but not a lower increase in utility. People always spend their money on what they desire and very likely nothing would change even if all taxes were eliminated as those utilities are very great. Taxation on utils would be optimal but is not available. There is a difference in labor, although in this case virtually none since few would have their laundry done anyway. Manufacturing and specialization always do better with larger markets and larger and more factories but may not equal more laundromats, but the greatest difference would not be in equipment but real estate, so less business capital would mean lower commercial property values, not what most people think of as investment, but lower commercial property values just mean more is available for other uses and slightly larger residential properties are desirable. Basically, a substitution assumption is unwarranted, but even if it were, the elimination of business capital would be a good thing as it means less is needed for production and more is available for consumption.
DeleteOn reflection I think you've brought up some good points. Let's think about this more carefully....
DeleteSo, we have capital gains tax and (sometimes) corporation tax paid on capital and things like VAT paid on durable goods. The owner must pay capital gains tax, so if by buying a new $4k washing machine he increases the value of his business by $5k then when he sells the business he must pay $1k * 0.3 = $300 per washing machine. Since all other laundromat owners are in the same situation that is a cost that's transferred to the consumer. Let's suppose that it increase the cost of laundering a shirt by 5% over what it would be if there were no CGT.
The same sort of logic applied to VAT on a home washing machine. It may increase the cost of laundering at home by, say, 3%. In that case taxies tip the scales in favour of home production. However, if it increases the cost of laundering at home by 7% then the opposite is true. We can't tell which is the case because it depends upon the nature of the different labour-capital trade-offs that take place in the two cases. In practice it would also depend on the way laundramat owners paid themselves profits, they may be able to avoid a lot of CGT. If laundramats are worth their book value and they are setup so they don't pay corporation tax then it's possible that they pay less taxes than the VAT. I think in practical businesses the situation will vary from case to case. In some industries and in some places the taxes on consumer durables will push people away from home production more than the taxes on capital push away entrepreneurs, but in other industries the opposite will be true. It won't come out in the wash, each industry will be less efficient than it would be otherwise, but the effect may be slight.
"I think the opposite is more likely the case. Laundromats would be smaller more intensive markets while home would be larger and more diverse. The laundromat wants extremely reliable heavy duty long lived machines while the home wants extremely diverse options, lighter duty and shorter lived demanding more advanced features and the larger market means more specialization is possible to cater to consumer tastes. I agree there is more value in the form of convenience, flexibility, and transport in doing it at home but there is no capital income difference as you would pay for the machines incrementally in one case and at once in the other and that is income to the laundromat or manufacturer. In the case of the laundromat that is passed along to the manufacturer as they would be a capital deduction. The increase in home production capital may offer a lower financial return, but not a lower increase in utility."
I'm not sure I understand what you're saying here. Could you explain it again in different words?
What we want is a level playing field. As you say, the demands of the home consumer aren't the same as those of the equivalent industry. Home production offers more convience for many people in this case. If there were no taxes in either case then these relative benefits and disadvantages would determine the prices, how common home washing-machines are and how common laundramats are. Taxes on these things fall in different ways over different timescales. They are unlikely to be fully equivalent. So, in practice when someone is asking themselves if the should buy a washing machine or use a laundramat the prices involved in that trade-off will include different taxes. But, I suppose that's life. Taxes have to be charged somewhere, and taxing labour only is just as bad if not worse in many cases. My examples above don't include labour taxes, but if they did it would clearly favour working on home production because that's untaxed (as you pointed out earlier).
"People always spend their money on what they desire and very likely nothing would change even if all taxes were eliminated as those utilities are very great."
DeleteThere are certainly cases where the utility of home production outweighs all other considerations. In those cases taxes won't have any effect. But that isn't always the case. In apartments, especially ones in expensive cities, people don't have washing machines because they take up too much space. In some places in Japan people don't have ovens or fridges to save space. At the other extreme, some houses have their own wells and sewage treatment. Some people grow a lot of their own food to save money. So, there are trade-offs, and it's at the margins where those trade-offs occur that the differences in taxes matter (as always).
"There is a difference in labor, although in this case virtually none since few would have their laundry done anyway. Manufacturing and specialization always do better with larger markets and larger and more factories but may not equal more laundromats, but the greatest difference would not be in equipment but real estate, so less business capital would mean lower commercial property values, not what most people think of as investment, but lower commercial property values just mean more is available for other uses and slightly larger residential properties are desirable. Basically, a substitution assumption is unwarranted, but even if it were, the elimination of business capital would be a good thing as it means less is needed for production and more is available for consumption."
I don't really understand this part of your reply either.