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The taxation of capital returns in overlapping generations models

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  • Dávila, Julio

Abstract

This paper shows that in the Diamond (1965) overlapping generations economy with production and capital savings, there is a period-by-period balanced fiscal policy supporting a steady state allocation that Pareto-improves upon the laissez-faire competitive equilibrium steady state (whether dynamically inefficient or efficient) without resorting to intergenerational transfers. The policy consists of taxing linearly (or subsidizing, in the dynamically efficient case) the returns to capital, while balancing the budget period by period through a lump-sum transfer (or tax, respectively) in second period. This intervention grants every generation the highest steady state utility attainable through markets (i.e. remunerating factors by their marginal productivities and without transfers) which under laissez-faire is not a competitive equilibrium outcome. A transition from the competitive equilibrium steady state to this other steady state is also Pareto-improving when the former is dynamically inefficient. The result disentangles from redistributive considerations the impact of the taxation of capital returns on steady state welfare, and thus provides a rationale for the taxation of capital returns that is based on efficiency considerations and not on redistributive goals.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 34 (2012)
Issue (Month): 2 ()
Pages: 441-453

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Handle: RePEc:eee:jmacro:v:34:y:2012:i:2:p:441-453

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Web page: http://www.elsevier.com/locate/inca/622617

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Keywords: Taxation of capital; Overlapping generations;

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  1. S. Rao Aiyagari, 1994. "Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting," Working Papers 508, Federal Reserve Bank of Minneapolis.
  2. Kenneth L. Judd, 1984. "The Welfare Cost of Factor Taxation in a Perfect Foresight Model," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 643, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Chamley, Christophe, 2001. "Capital income taxation, wealth distribution and borrowing constraints," Journal of Public Economics, Elsevier, vol. 79(1), pages 55-69, January.
  4. Juan C. Conesa & Dirk Krueger, 2004. "Taxing Capital: Not a Bad Idea After All," 2004 Meeting Papers 403, Society for Economic Dynamics.
  5. Emmanuel Saez, 2002. "Optimal Progressive Capital Income Taxes in the Infinite Horizon Model," NBER Working Papers 9046, National Bureau of Economic Research, Inc.
  6. Erosa, Andres & Gervais, Martin, 2002. "Optimal Taxation in Life-Cycle Economies," Journal of Economic Theory, Elsevier, vol. 105(2), pages 338-369, August.
  7. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 93(2), pages 223-47, April.
  8. Diamond, Peter A., 1970. "Incidence of an interest income tax," Journal of Economic Theory, Elsevier, vol. 2(3), pages 211-224, September.
  9. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, Econometric Society, vol. 54(3), pages 607-22, May.
  10. Andrew Atkeson & V.V. Chari & Patrick J. Kehoe, 1999. "Taxing capital income: a bad idea," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-17.
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  1. repec:fip:fedlps:y:2012:i:may30 is not listed on IDEAS
  2. Bullard, James & Garriga, Carlos & Waller, Christopher J., 2012. "Demographics, redistribution, and optimal inflation," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 419-440.

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