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Taxing capital is a good idea: The role of idiosyncratic risk in an OLG model

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  • Hiraguchi, Ryoji
  • Shibata, Akihisa

Abstract

We investigate an overlapping generations (OLG) model in which agents who live for two periods receive idiosyncratic productivity shocks when they are old. We show that, around zero tax equilibria, we can always construct a combination of a small capital tax and a lump-sum transfer that are Pareto-improving. As Dávila et al. (Econometrica (2012)) show, a capital reduction in one period raises the welfare level of agents who are old in that period, but lowers that of the young agents, because it reduces their wages. We show that the government can compensate for these wage losses by additionally taxing the old agents, such that their welfare gains remain positive. Our result is unchanged when earnings are uncertain at young age.

Suggested Citation

  • Hiraguchi, Ryoji & Shibata, Akihisa, 2015. "Taxing capital is a good idea: The role of idiosyncratic risk in an OLG model," Journal of Economic Dynamics and Control, Elsevier, vol. 52(C), pages 258-269.
    • Handle: RePEc:eee:dyncon:v:52:y:2015:i:c:p:258-269
    DOI: 10.1016/j.jedc.2014.12.003
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    1. Erosa, Andres & Gervais, Martin, 2002. "Optimal Taxation in Life-Cycle Economies," Journal of Economic Theory, Elsevier, vol. 105(2), pages 338-369, August.
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    3. Rieth, Malte, 2017. "Capital taxation and government debt policy with public discounting," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 1-20.

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    More about this item

    Keywords

    Idiosyncratic risk; Capital tax; Incomplete markets; Overlapping generations;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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