In an economy with identical infinitely-lived households that obtain utility from leisure as well as consumption, Chamley (1986) and Judd (1985) have shown that the optimal tax system to pay for an exogenous stream of government purchases involves a zero tax rate on capital in the long run, with tax revenue collected by a distortionary tax on labor income. Extending the results of Hall and Jorgenson (1971) to general equilibrium, I show that if purchasers of capital are permitted to deduct capital expenditures from taxable capital income, then a constant tax rate on capital income is non-distortionary. Importantly, even though this specification of the capital income tax imposes a zero effective tax rate on capital, the capital income tax can collect substantial revenue. Provided that government purchases do not exceed gross capital income less gross investment, the optimal tax system will consist of a positive tax rate on capital income and a zero tax rate on labor income--just the opposite of the results of Chamley and Judd.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13354.
Length: Date of creation: Aug 2007 Date of revision: Handle: RePEc:nbr:nberwo:13354
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Find related papers by JEL classification: E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
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