Tax Policy and Toxic Housing Bubbles in China

Abstract

This paper explores the effects of a government tax policy in a growth model with economic transition and toxic housing bubbles applied to China. Such a policy combines taxing entrepreneurs with a one-time redistribution to workers in the same period. Under the tax policy, we find that the welfare improvement for workers is non-monotonic. In particular, there exists an optimal tax at which social welfare is maximized. Moreover, we consider the welfare effects of setting the tax at its optimum. We show that the tax policy can be welfare-enhancing, comparing to the case without active policies. The optimal tax may also yield a higher level of welfare than the case even without housing bubbles. In addition, our simple numerical exercise shows that the optimal tax rate is about 23%;, and social welfare is significantly improved with such a tax policy. Finally, we extend the benchmark economy to a multi-period setting and calibrate the model to China. Our results show that a 20%; tax rate can speed up economic transition and increase output growth. Between 1998 and 2012, aggregate consumption is 4.86%; higher under active tax policies.

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