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Taxing capital is a good idea: the role of idiosyncratic risk in an OLG model

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  • Ryoji Hiraguchi

    ()
    (Faculty of Economics, Ritsumeikan University)

  • Akihisa Shibata

    ()
    (Institute of Economic Research, Kyoto University)

Abstract

We investigate an overlapping generations model (OLG) model in which agents who live for two periods receive idiosyncratic productivity shocks when they are old. We show that a combination of lump-sum and linear capital taxes can always Pareto-improve the allocation, that is, it can raise the equilibrium welfare of one generation without affecting that of the others. As D?vila et al. (Econometrica (2012)) show, a capital reduction in one period raises the welfare levels of agents who are old in that period, but lowers that of the young agents, because it reduces their wages. We show that the government can compensate for these wage losses by additionally taxing the old agents, such that their welfare gains remain positive.

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Bibliographic Info

Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 853.

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Length: 20pages
Date of creation: Mar 2013
Date of revision:
Handle: RePEc:kyo:wpaper:853

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Keywords: idiosyncratic risk; capital tax; incomplete markets; overlapping generations;

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