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The Optimal Tax Rate for Capital Income is Negative

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  • Kenneth L. Judd

Abstract

We examine the problem of optimal taxation in a dynamic economy with imperfectly competitive markets. We find that the optimal tax system will tend to provide subsidies for the purchase of capital goods to offset gaps between price and marginal cost. The average tax on capital income will be negative, even if pure profits are not taxed away and even if the alternative distortionary taxes have an infinite efficiency cost. These arguments hold even if it is necessary to tax consumption goods which also sell above marginal cost; the difference is that capital goods are intermediate goods and consumption goods are final goods. Since observed markups are greater for equipment than for construction, this analysis justifies the Investment Tax Credit's discrimination in favor of equipment over structures.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6004.

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Date of creation: Apr 1997
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Handle: RePEc:nbr:nberwo:6004

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  1. Jones, Larry E. & Manuelli, Rodolfo E. & Rossi, Peter E., 1997. "On the Optimal Taxation of Capital Income," Journal of Economic Theory, Elsevier, Elsevier, vol. 73(1), pages 93-117, March.
  2. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Kenneth L. Judd, 1984. "The Welfare Cost of Factor Taxation in a Perfect Foresight Model," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 643, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Stiglitz, Joseph E & Dasgupta, P, 1971. "Differential Taxation, Public Goods and Economic Efficiency," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(114), pages 151-74, April.
  5. Bulow, Jeremy I, 1982. "Durable-Goods Monopolists," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(2), pages 314-32, April.
  6. Ian Domowitz & R. Glenn Hubbard & Bruce C. Petersen, 1986. "Business Cycles and the Relationship Between Concentration and Price-Cost Margins," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 1-17, Spring.
  7. Judd, Kenneth L., 1999. "Optimal taxation and spending in general competitive growth models," Journal of Public Economics, Elsevier, Elsevier, vol. 71(1), pages 1-26, January.
  8. Domowitz, Ian & Hubbard, R Glenn & Petersen, Bruce C, 1986. "The Intertemporal Stability of the Concentration-Margins Relationship," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 35(1), pages 13-34, September.
  9. Judd, Kenneth L, 1985. "On the Performance of Patents," Econometrica, Econometric Society, Econometric Society, vol. 53(3), pages 567-85, May.
  10. Myles, Gareth D., 1989. "Ramsey tax rules for economies with imperfect competition," Journal of Public Economics, Elsevier, Elsevier, vol. 38(1), pages 95-115, February.
  11. Domowitz, Ian & Hubbard, R Glenn & Petersen, Bruce C, 1987. "Oligopoly Supergames: Some Empirical Evidence on Prices and Margins," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 35(4), pages 379-98, June.
  12. Appelbaum, Elie, 1982. "The estimation of the degree of oligopoly power," Journal of Econometrics, Elsevier, Elsevier, vol. 19(2-3), pages 287-299, August.
  13. Nancy L. Stokey, 1981. "Rational Expectations and Durable Goods Pricing," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 12(1), pages 112-128, Spring.
  14. Peter A. Diamond & J. A. Mirrlees, 1968. "Optimal Taxation and Public Production," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 22, Massachusetts Institute of Technology (MIT), Department of Economics.
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