Tax policy can change the size of the economy and American incomes by changing whether (and how much) people work and invest in the US.
People respond to incentives on the margin when making decisions to work or invest. As the after-tax returns to additional work or investment fall, people work and invest less. Investment and work opportunities that would have broken even before are no longer viable to pursue.
Less work and lower investment reduce the long-run size of the American economy, American incomes, the capital stock, and the number of full-time equivalent jobs.
Some tax changes can create a wedge between GDP (American output) and GNP (American incomes). Taxes levied on domestic saving, such as capital gains taxes, would reduce the return to saving, and, in response, people would save less, which would reduce the ownership of American investment by residents. Because the US economy is open to international investment, foreign investors who are not subject to the tax may provide additional funds to finance domestic investments.
While increased international investment reduces the effect of the tax change on GDP, it would change who owns assets, resulting in less ownership of US assets by Americans and a decrease in national income as the profits flow to foreign owners instead.
