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What does the capital income tax distort?

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Author Info
Jinyong Cai
Jagadeesh Gokhale
Abstract

In addition to taxing future consumption (including leisure), capital income taxation subsidizes the consumption of durables. the taxation of future consumption may be characterized as an intertemporal distortion, while the subsidy to durables may be characterized as a static distortion. the magnitude of this intertemporal distortion has received considerable attention, but few analyses have dealt with the static distortion. ; This paper decomposes the excess burden arising from capital income taxation into its static and intertemporal components. the analysis is based on a life-cycle model with a constant elasticity of substitution utility function in one durable and one nondurable good. Calculations indicate that for reasonable utility parameters, the static component of the excess burden is of the same order of magnitude as the intertemporal component. in the case of major durable goods such as housing, which have relatively low depreciation rates, the static component is large and may exceed the intertemporal component. This suggests that an additional tax on the purchase of new durable goods would significantly reduce the overall excess burden arising from a capital income tax.

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Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 9013.

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Date of creation: 1990
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Handle: RePEc:fip:fedcwp:9013

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Keywords: Income tax ; Finance; Public;

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  1. Auerbach, Alan J & Kotlikoff, Laurence J & Skinner, Jonathan, 1983. "The Efficiency Gains from Dynamic Tax Reform," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 24(1), pages 81-100, February. [Downloadable!] (restricted)
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  2. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April. [Downloadable!] (restricted)
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  3. Feldstein, Martin S, 1978. "The Welfare Cost of Capital Income Taxation," Journal of Political Economy, University of Chicago Press, vol. 86(2), pages S29-51, April. [Downloadable!] (restricted)
  4. Auerbach, Alan J., 1989. "The deadweight loss from `non-neutral' capital income taxation," Journal of Public Economics, Elsevier, vol. 40(1), pages 1-36, October. [Downloadable!] (restricted)
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  5. Chamley, Christophe, 1981. "The Welfare Cost of Capital Income Taxation in a Growing Economy," Journal of Political Economy, University of Chicago Press, vol. 89(3), pages 468-96, June. [Downloadable!] (restricted)
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  6. Levhari, David & Sheshinski, Eytan, 1972. "Lifetime Excess Burden of a Tax," Journal of Political Economy, University of Chicago Press, vol. 80(1), pages 139-47, Jan.-Feb.. [Downloadable!] (restricted)
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