4.1 Income and Welfare Effects
Introducing a draft system has negative effects in the long run on income and
consumption. This is driven partly by direct effects on draftees, and partly by
indirect general equilibrium effects of changes in factor prices on the behavior of
non-draftees. Table 2 shows that GDP and consumption decrease with 0.2 percent
when 25 percent of the population is subject to draft and the supplementary tax
rate is equal to 0. The reduction in private saving is more significant than the
fall in labor services, and the capital intensity goes down. The decrease in capital
intensity drives up the return on physical capital and drives down the gross wage
rate. The reduction in labor income erodes the tax revenue from the tax rate on
labor income, and the tax rate on labor income goes up. The negative impact
on the economy is more significant when the share of the population subject
draft increases, and GDP decreases by 0.7 percent when the entire population is
subject to draft and the supplementary tax rate is equal to 0.
Table 2. Effects of move to draft system (percentage change from initial steady state equilibrium)a
|
Share of population subject to draft |
100 percent | ||||||||
|
25 percent |
50 percent | ||||||||
|
Supplementary tax rate |
Supplementary tax rate |
Supplementary tax rate | |||||||
|
0% |
50% |
100% |
0% |
50% |
100% |
0% |
50% |
100% | |
|
GDP |
-0.2 |
-0.5 |
-0.8 |
-0.4 |
-0.9 |
-1.5 |
-0.7 |
-1.9 |
-3.0 |
|
Consumption |
-0.2 |
-0.6 |
-1.0 |
-0.5 |
-1.1 |
-1.9 |
-0.9 |
-2.3 |
-3.7 |
|
Physical capital stock |
-0.3 |
-0.8 |
-1.3 |
-0.5 |
-1.5 |
-2.6 |
-1.0 |
-3.1 |
-5.2 |
|
Labor services |
-0.1 |
-0.3 |
-0.6 |
-0.3 |
-0.7 |
-1.1 |
-0.6 |
-1.3 |
-2.1 |
|
Rental rate on physical capital |
0.08 |
0.29 |
0.51 |
0.16 |
0.61 |
1.07 |
0.33 |
1.24 |
2.23 |
|
Wage rate |
-0.04 |
-0.13 |
-0.23 |
-0.07 |
-0.28 |
-0.48 |
-0.15 |
-0.56 |
-1.00 |
|
Tax rate on labor incomeb |
0.18 |
0.12 |
0.08 |
0.35 |
0.23 |
0.13 |
0.69 |
0.45 |
0.26 |
Note: (a) the initial tax rate on wage income is 37.5 percent, (b) measured in percentage points.
Table 2 also shows that supplementary tax payments by conscripts increase
the negative effects on income and consumption. The revenue from the supple-
mentary tax rate is spent on a reduction in the tax rate on labor income, and the
reform thus transfers income from conscripts to non-conscripts, and from young
generations to old generations who are not subject to draft. The impact on the
economy may be significant. For example, GDP falls by 3 percent if the entire
population is subject to draft and no income is paid during conscription. Most of
the decrease in GDP is due to reduced private saving, and the capital intensity
in the economy drops further. Changes in net factor prices thus move further
apart, with an increase in the return on physical capital and a decrease in the
net wage rate.
Figures 3a and 3b illustrate the effects on individual learning decisions when
25 percent of the population is subject to conscription and the supplementary tax
rate on net wage income is 50 percent. Conscripts are forced to spend available
time on work in the first period of the life cycle, where labor productivity is low
12