The total tax revenue from the proportional and supplementary tax rates on
wage income on the left-hand side is equal to the cost of public provision of goods
and services on the right-hand side.
2.4 Welfare Effects
We use the equivalent variation measure to assess the welfare effects of introduc-
ing conscription. This measure is derived as the percentage change in lifetime
earnings necessary to yield the utility level reached in the new steady state. More
formally, it is determined by:
L^i(Eijo ∙ (1 + χi),r0,w0) = t^i(Eijι,rι,wι) (13)
where ^ denotes the indirect utility function for group i = c,n, and Ei is the net
present value of group i’s lifetime income. As we focus on the factor prices faced
by individuals, we define wo and w1 to measure after-tax wage rates. Therefore,
they combine the changes in gross wage rates and in wage tax rates. The sub-
scripts 0 and 1 denote initial steady state values without and with conscription,
respectively. The variable χi measures the change in group i’s welfare between
the two steady states. This welfare measure can be compared across different
steady states and is applicable for changes of any size and not only differential
approximations.
3 Calibration
There is no draft system in the initial steady state equilibrium, i.e. there is
initially no distinction between conscripts and non-conscripts. The model is cali-
brated to the data set presented in Table 1, and the following standard parameter
values are applied in the baseline scenario. Capital income accounts for 31.2 per-
cent of GDP and labor income accounts for 68.8 percent of GDP, which implies
that the labor-capital income ratio is equal to 2.2. The level of investment is equal
to 20.8 percent of GDP, given a net interest rate of 5 percent and a 10 percent
depreciation rate with respect to physical capital. To achieve a su¢ciently high
private saving rate, the rate of time preference is set equal to 3.1 percent. We
assume that the intertemporal elasticity of substitution is equal to 0.667, which
is within the range from 0.5 to 1 that is used in most numerical studies.
The tax revenue from the wage income tax in the initial steady state is equal
to 25.8 percent of GDP. This revenue is achieved by a 37.5 percent tax rate on