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Pareto-Improving Optimal Capital and Labor Taxes

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  • Katharina Greulich
  • Albert Marcet

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 Chamleys, 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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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 337.

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Date of creation: Feb 2008
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Handle: RePEc:bge:wpaper:337

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  1. Faraglia, Elisa & Marcet, Albert & Scott, Andrew, 2010. "In search of a theory of debt management," Journal of Monetary Economics, Elsevier, vol. 57(7), pages 821-836, October.
  2. Aiyagari, S Rao, 1995. "Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1158-75, December.
  3. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  4. Albert Marcet & Francesc Obiols-Homs & Philippe Weil, 2003. "Incomplete Markets, Labor Supply and Capital Accumulation," Working Papers 173, Barcelona Graduate School of Economics.
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  7. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
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  9. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Iván Werning, 2007. "Optimal Fiscal Policy with Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 122(3), pages 925-967, 08.
  11. Andrew Atkeson & V.V. Chari & Patrick J. Kehoe, 1999. "Taxing capital income: a bad idea," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-17.
  12. Ellen McGrattan & Richard Rogerson & Randall Wright, 1995. "An equilibrium model of the business cycle with household production and fiscal policy," Staff Report 191, Federal Reserve Bank of Minneapolis.
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  14. Floden, Martin, 2009. "Why Are Capital Income Taxes So High?," Macroeconomic Dynamics, Cambridge University Press, vol. 13(03), pages 279-304, June.
  15. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Economics Working Papers ECO2011/15, European University Institute.
  16. Juan Carlos Conesa & Dirk Krueger, 2002. "On the Optimal Progressivity of the Income Tax Code," Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP) 4, Centro de Altisimos Estudios Rios Perez (CAERP).
  17. Correia, Maria Isabel Horta, 1995. "Efficiency and Equity: Is There a Trade-off?," CEPR Discussion Papers 1218, C.E.P.R. Discussion Papers.
  18. Niepelt, Dirk, 2002. "Tax Smoothing versus Tax Shifting," Seminar Papers 711, Stockholm University, Institute for International Economic Studies.
  19. 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.
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  21. 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, vol. 101(3), pages 485-517, June.
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Cited by:
  1. Angelopoulos, Konstantinos & Malley, James & Philippopoulos, Apostolis, 2011. "Time-consistent fiscal policy under heterogeneity: Conflicting or common interests?," SIRE Discussion Papers 2011-41, Scottish Institute for Research in Economics (SIRE).
  2. Sofía Bauducco, 2011. "Seigniorage and Distortionary Taxation in a Model with Heterogeneous Agents and Idiosyncratic Uncertainty," Working Papers Central Bank of Chile 611, Central Bank of Chile.

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