We study optimal capital income taxation with a Ramsey problem and relate this optimal taxation problem to the question that has been asked in the asset pricing literature, which is why the risk free interest rate is too low. We show that the Ramsey planner chooses the optimal level of capital stock to be one that satisfies the modified golden rule in the steady state under some conditions. The conditions include suffcient government tax instruments and ability to issue bonds. We argue that the optimal capital level is different from that chosen in a competitive equilibrium unless the competitive equilibrium risk free interest rate is same as the time discount rate in the steady state. This difference in the choice of capital motivates imposing a positive capital income tax (or subsidy) on households to induce them to invest at the socially optimal amount. As examples, we investigate optimal capital taxation in a decentralized economy with limited commitment and one with private information. However, the result still holds in various types of economies with risk free interest rate that is too low.
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Paper provided by Australian National University, College of Business and Economics, School of Economics in its series ANUCBE School of Economics Working Papers with number
2008-497.
Yili Chien & Junsang Lee, 2009.
"Why Tax Capital?,"
CAMA Working Papers
2009-05, Australian National University, Centre for Applied Macroeconomic Analysis.
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Find related papers by JEL classification: D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law E23 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Production E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Albert Marcet & Ramon Marimon, 1994.
"Recursive Contracts,"
Economics Working Papers
337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
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Chari, V.V. & Kehoe, Patrick J., 1999.
"Optimal fiscal and monetary policy,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745
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