Optimal Capital Taxation Under Limited Commitment

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Optimal Capital Taxation Under Limited Commitment

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Yili Chien ()
Junsang Lee ()

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YiLi Chien

Abstract

We study optimal capital taxation under limited commitment. We prove that the optimal tax rate on capital income should be positive in steady state provided that full risk-sharing is not feasible. In a limited commitment environment, a one unit increase of capital investment by an agent increases all individuals' autarky values in the economy and generates externality costs in the economy. This externality cost provides a rationale for positive capital taxation even in the absence of government expenditure. Moreover, we show that both this externality cost of capital investment and the optimal tax rate are potentially much bigger than one might expect.

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Paper provided by Australian National University, Centre for Applied Macroeconomic Analysis in its series CAMA Working Papers with number 2009-06.

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Length: 30 pages
Date of creation: Jan 2009
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Handle: RePEc:acb:camaaa:2009-06

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Paper
- YiLi Chien & JunSang Lee, 2006. "Optimal Capital Taxation under Limited Commitment," 2006 Meeting Papers 430, Society for Economic Dynamics.
- Junsang Lee & Yili Chien, 2008. "Optimal Capital Taxation Under Limited Commitment," ANUCBE School of Economics Working Papers 2008-498, Australian National University, College of Business and Economics, School of Economics. [Downloadable!]

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-06-10 (All new papers)
NEP-DGE-2009-06-10 (Dynamic General Equilibrium)
NEP-PUB-2009-06-10 (Public Finance)

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