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Accounting for the "disconnectedness" of the economy in OLG models: A case for taxing capital income

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  • Spataro, Luca
  • De Bonis, Valeria

Abstract

The paper extends the works by Judd [K.L. Judd, Redistributive Taxation in a Simple Perfect Foresight Model, J. Public Econ. 28 (1985), 59-83.] and Chamley [C. Chamley, Optimal taxation of capital income in general equilibrium with infinite lives, Econometrica, 54 (1986), 607-622.], who establish that in the long run the capital income tax should be zero, by considering a discrete time version of the Blanchard-Buiter-Weil perpetual youth model. We show that an independent source of non-zero taxation arises whenever the economy is "disconnected" and this feature is properly taken into account by the policymaker. More precisely, if the weight attached to each cohort in the social welfare function equals the corresponding actual share in the population, there is a force pushing towards positive taxation of capital income, which acts as a Pigouvian intervention. Moreover, room for this intertemporal correction shrinks as the relative weight of a cohort tends to zero: thus, the optimal tax rate decreases with age and tends to zero for the oldest. We also show that our result depends neither on life-cycle behavior, as pointed out by the previous literature on OLG models, nor on population growth.

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Bibliographic Info

Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 25 (2008)
Issue (Month): 3 (May)
Pages: 411-421

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Handle: RePEc:eee:ecmode:v:25:y:2008:i:3:p:411-421

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Web page: http://www.elsevier.com/locate/inca/30411

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  1. Atkinson, A B & Sandmo, A, 1980. "Welfare Implications of the Taxation of Savings," Economic Journal, Royal Economic Society, vol. 90(359), pages 529-49, September.
  2. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  3. de la Croix,David & Michel,Philippe, 2002. "A Theory of Economic Growth," Cambridge Books, Cambridge University Press, number 9780521806428.
  4. repec:fth:louvco:9039 is not listed on IDEAS
  5. Bernheim, B Douglas, 1989. "Intergenerational Altruism, Dynastic Equilibria and Social Welfare," Review of Economic Studies, Wiley Blackwell, vol. 56(1), pages 119-28, January.
  6. Andrew Caplin & John Leahy, 2000. "The Social Discount Rate," NBER Working Papers 7983, National Bureau of Economic Research, Inc.
  7. Weil, Philippe, 1989. "Overlapping families of infinitely-lived agents," Journal of Public Economics, Elsevier, vol. 38(2), pages 183-198, March.
  8. Emmanuel Farhi & Ivan Werning, 2005. "Inequality, Social Discounting and Estate Taxation," NBER Working Papers 11408, National Bureau of Economic Research, Inc.
  9. De Bonis, Valeria & Spataro, Luca, 2005. "Taxing Capital Income As Pigouvian Correction: The Role Of Discounting The Future," Macroeconomic Dynamics, Cambridge University Press, vol. 9(04), pages 469-477, September.
  10. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  11. MICHEL, Philippe, 1990. "Criticism of the social time-preference hypothesis in optimal growth," CORE Discussion Papers 1990039, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  12. Andrés Erosa & Martin Gervais, 1998. "Optimal Taxation in Life-Cycle Economies," UWO Department of Economics Working Papers 9812, University of Western Ontario, Department of Economics.
  13. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  14. Buiter, Willem H, 1988. "Death, Birth, Productivity Growth and Debt Neutrality," Economic Journal, Royal Economic Society, vol. 98(391), pages 279-93, June.
  15. Judd, Kenneth L., 1999. "Optimal taxation and spending in general competitive growth models," Journal of Public Economics, Elsevier, vol. 71(1), pages 1-26, January.
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Cited by:
  1. Spataro, Luca & Renström, Thomas I., 2012. "Optimal taxation, critical-level utilitarianism and economic growth," Journal of Public Economics, Elsevier, vol. 96(9-10), pages 727-738.
  2. Ronald Wendner, 2009. "Conspicuous Consumption and Overlapping Generations?," EERI Research Paper Series EERI_RP_2009_05, Economics and Econometrics Research Institute (EERI), Brussels.

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