Public Finance, 3rd Edition

Dynamic Tax Incidence

The early models of tax incidence were static, one-period models. Dynamic models were sure to follow, however, because the dynamic analysis of tax incidence has three huge advantages over static analysis.

First and foremost, a dynamic model can track the evolution of the capital stock in response to tax policies. Changes in the capital stock through time affect the marginal products of capital, labor, and all other factors of production, which determine the real returns to the factors in a competitive environment. These capital-induced changes in the returns to factors over time tend to swamp any direct short-run effects that tax policies might have on factor returns.

Second, a dynamic model can consider intergenerational tax ...