In this paper, we present a quantitative analysis of international capital flows induced by differences in population aging processes across countries and by pension reforms. In the vast majority of countries, demographic change will continue well into the 21 st century. It is well known that within each country, demographic change alters the time path of aggregate savings, even more so in countries where fundamental pension reforms and shifts towards more pre-funding are implemented. While the patterns of population aging are similar in most countries, the timing differs substantially, in particular between industrialized and less developed countries. To the extent that capital is internationally mobile, population aging will therefore induce capital flows between countries. In order to quantify these effects, we develop a stylized multi-country overlapping generations model, and we use long-term demographic projections for several world regions to simulate international capital flows over a 50 year horizon. Our simulations suggest that capital flows from fast-aging industrial countries such as Germany to the rest of the world will be substantial. Closed-economy models of pension

Entrepreneurship is a key determinant of investment, saving, wealth holdings, and wealth inequality. We study the aggregate and the distributional effects of several tax reforms in a model that recognizes the key role played by the entrepreneurs, and that matches very well the extreme degree of wealth inequality observed in the U.S. data. We find that the effects of tax reforms on output and capital formation can be particularly large when they affect the majority of small and medium-size businesses, which face the most severe financial constraints, rather than a small number of big businesses. We show that the consequences of changes in the estate tax depend heavily on the size of its exemption level. The current effective estate tax system seems to insulate most of the businesses from the negative effects of estate taxation thus minimizing the aggregate costs of redistribution. Abolishing the current estate tax would generate a modest increase in wealth inequality and slightly reduce aggregate output. Decreasing progressivity of the income tax can generate large increases in output, as this stimulates entrepreneurial savings and capital formation, but at the cost of large increases in wealth concentration.

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This paper is being prepared for a forthcoming volume of the Handbook of Public Economics, edited by Alan Auerbach and Martin Feldstein. We thank Alan Auerbach and Tom Barthold for helpful suggestions. p. 1

Capital taxation which is negatively correlated with labor supply is proposed. This paper uses a life-cycle model of heterogeneous agents that face idiosyncratic productivity shocks and shows that the tax scheme provides a strong work incentive when households possess large assets and high productivity later in the life-cycle, when they otherwise would work less. The system also adds to the saving motive of prime-age households and raises aggregate capital. The increased economic activities expand the tax base and the revenue neutral reform results in a lower average tax rate. The negative cross dependence generates a sizeable welfare gain in the long-run relative to the tax system that treats labor and capital income separately as a tax base. The reform, however, can hurt the elderly during the transition with a high marginal tax on their capital income.

The UK economy growing annually at 2.05 percent and leading the world between 1750 and 1850 experienced a sharp rise in income inequality at the high point of the industrial revolution. A series of tax and transfer enactments from the parliament to protect workers and low income households started towards the end of the nineteenth century reversed this trend making Britain one of the most egalitarian economy in the world by 1960s. New wave of reforms in tax-transfer system and the markets in the last forty years aimed at higher economic growth have raised inequality again both in the original and the post tax income causing widespread concerns. Solutions of the multi- household, multi-sectoral dynamic general equilibrium model show that …scal policy measures impact on growth paths, capital accumulation and investment processes across sectors and in the distribution of income among households. Greater equality does not automatically guarantee greater welfare when the economy is not growing. By taking account of the intertemporal income and substitution e¤ects this model can provide more accurate analysis of impacts of …scal policy measures on the labour-leisure and consumption decisions of households and input choices of …rms. Such analysis is helpful in setting a long-term optimal policy measures based on structural realities to maintain a balance between growth and equity in the 21st century.

NOTE: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB. Acknowledgements