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Pareto-Improving Optimal Capital and Labor Taxes

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  • Albert Marcet

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  • Katharina Greulich

    ()

Abstract

We show a standard model where the optimal tax reform is to cut labor taxes and leave capital taxes very high in the short and medium run. Only in the very long run would capital taxes be zero. Our model is a version of Chamley??s, with heterogeneous agents, without lump sum transfers, an upper bound on capital taxes, and a focus on Pareto improving plans. For our calibration labor taxes should be low for the first ten to twenty years, while capital taxes should be at their maximum. This policy ensures that all agents benefit from the tax reform and that capital grows quickly after when the reform begins. Therefore, the long run optimal tax mix is the opposite from the short and medium run tax mix. The initial labor tax cut is financed by deficits that lead to a positive long run level of government debt, reversing the standard prediction that government accumulates savings in models with optimal capital taxes. If labor supply is somewhat elastic benefits from tax reform are high and they can be shifted entirely to capitalists or workers by varying the length of the transition. With inelastic labor supply there is an increasing part of the equilibrium frontier, this means that the scope for benefitting the workers is limited and the total benefits from reforming taxes are much lower.

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Paper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 733.08.

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Length: 54
Date of creation: 19 Feb 2008
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Handle: RePEc:aub:autbar:733.08

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  1. Correia, Maria Isabel Horta, 1995. "Efficiency and Equity: Is There a Trade-off?," CEPR Discussion Papers 1218, C.E.P.R. Discussion Papers.
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  7. Albert Marcet & Francesc Obiols-Homs & Philippe Weil, 2002. "Incomplete markets, labor supply and capital accumulation," Economics Working Papers 659, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2003.
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  15. Iván Werning, 2007. "Optimal Fiscal Policy with Redistribution," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 122(3), pages 925-967, 08.
  16. Teresa Garcia-Milà & Albert Marcet & Eva Ventura, 1995. "Supply side interventions and redistribution," Economics Working Papers 115, Department of Economics and Business, Universitat Pompeu Fabra.
  17. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal fiscal policy in a business cycle model," Staff Report, Federal Reserve Bank of Minneapolis 160, Federal Reserve Bank of Minneapolis.
  18. 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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  20. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 101(3), pages 485-517, June.
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Cited by:
  1. Konstantinos Angelopoulos & James Malley & Apostolis Philippopoulos, 2011. "Time-consistent fiscal policy under heterogeneity: Conflicting or common interests?," Working Papers, Business School - Economics, University of Glasgow 2011_06, Business School - Economics, University of Glasgow.
  2. Sofía Bauducco, 2011. "Seigniorage and Distortionary Taxation in a Model with Heterogeneous Agents and Idiosyncratic Uncertainty," Working Papers Central Bank of Chile, Central Bank of Chile 611, Central Bank of Chile.

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