Capital Depreciation Allowances and Redistribution in a Neoclassical Growth Model

In this paper it is analyzed whether capital depreciation allowances when coupled with capital income taxes are good instruments for redistribution in the long run. The analysis is placed in a simple two-agent-economy with capital owners and workers, and suggests that in the short run and absent optimizing behaviour accelerated depreciation is good for growth and may stabilize investment in a recession but is generally bad for redistribution. The opposite holds for capital income taxes. However, when the private sector and the government act optimally the optimal depreciation allowance is maximal in the long run. This removes the accumulation distortion of capital income taxes. Furthermore, the latter and so redistribution may be nonzero, depending i.a. on the social weight of those who receive redistributive transfers, the distribution of pre-tax factor incomes, and the intertemporal elasticity of substitution. It is argued that accelerated depreciation allowances, extensively used in the current economic crisis, are an important indirect tool for redistribution.