Fiscal Policies Aimed at Spurring Capital Formation: A Framework for Analysis

In recent years, policymakers have proposed various fiscal policies to spur long-run economic growth through increased capital formation. The Bush Administration, for example, proposed lowering the capital gains tax rate. The Clinton Administration, among other measures in its economic package, proposed reinstituting the investment tax credit. These proposals stem from heightened concerns that the U.S. economy has been growing by less than its long-run potential, and from the judgment that this subpar growth is due in part to deficient capital formation.> Chirinko and Morris present a framework for examining fiscal policies aimed at spurring capital formation and highlight the conditions for their success. First, they show why capital formation is an important determinant of economic growth. Second, they show how the optimal amount of capital formation, and therefore economic growth, is determined. Third, they show how economic distortions can cause capital formation to fall short of the socially optimal amount. Finally, they discuss several fiscal policies that have been proposed to raise capital formation.