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Optimal Capital Taxation and Consumer Uncertainty

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  • Ryan Chahrour

    ()
    (Department of Economics, Boston College)

  • Justin Svec

    ()
    (Department of Economics, College of the Holy Cross)

Abstract

This paper analyzes the impact of consumer uncertainty on optimal fiscal policy in a model with capital. The consumers lack confidence about the probability model that characterizes the stochastic environment and so apply a max-min operator to their optimization problem. An altruistic fiscal authority does not face this Knightian uncertainty. We show analytically that, in responding to consumer uncertainty, the government no longer sets the expected capital tax rate exactly equal to zero, as is the case in the full-confidence benchmark model. Rather, our numerical results indicate that the government chooses to subsidize capital income, albeit at a modest rate. We also show that the government responds to consumer uncertainty by smoothing the labor tax across states and by making the labor tax persistent.

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File URL: http://college.holycross.edu/RePEc/hcx/Chahrour-Svec_OptimalCapitalTaxation.pdf
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Bibliographic Info

Paper provided by College of the Holy Cross, Department of Economics in its series Working Papers with number 1108.

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Length: 42 pages
Date of creation: Mar 2014
Date of revision:
Handle: RePEc:hcx:wpaper:1108

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Keywords: Model uncertainty; capital income tax; public debt;

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References

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  2. Hansen, Lars Peter & Sargent, Thomas J., 2005. "Robust estimation and control under commitment," Journal of Economic Theory, Elsevier, vol. 124(2), pages 258-301, October.
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  8. 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.
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  24. Dennis, Richard, 2010. "How robustness can lower the cost of discretion," Journal of Monetary Economics, Elsevier, vol. 57(6), pages 653-667, September.
  25. Justin Svec, 2010. "Optimal Fiscal Policy with Robust Control," Working Papers 1004, College of the Holy Cross, Department of Economics.
  26. Ireland, Peter N., 2003. "Comment on: Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 977-982, July.
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Cited by:
  1. Robert Baumann & Justin Svec, 2013. "The Impact of Political Uncertainty: A Robust Control Approach," Working Papers 1306, College of the Holy Cross, Department of Economics.
  2. Svec, Justin, 2012. "Optimal fiscal policy with robust control," Journal of Economic Dynamics and Control, Elsevier, vol. 36(3), pages 349-368.

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