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Optimal capital taxation for time-nonseparable preferences

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  • Koehne, Sebastian
  • Kuhn, Moritz

Abstract

This paper studies the effect of habit formation on optimal capital taxes in a dynamic Mirrleesian model. We make three distinct contributions. First, we decompose intertemporal wedges (implicit capital taxes) for general time-nonseparable preferences into a wealth effect, a complementarity effect, and a future incentive effect. Second, we provide conditions under which intertemporal wedges are positive. Third, we derive a recursive formulation of constrained efficient allocations and evaluate the quantitative impact of habit formation. In a model parameterized to the U.S. economy, habit formation reduces average intertemporal wedges by about 40 percent compared to the time-separable case. Moreover, intertemporal wedges are close to zero for the largest part of the working life.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 45203.

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Date of creation: 18 Mar 2013
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Handle: RePEc:pra:mprapa:45203

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Keywords: optimal taxation; intertemporal wedge; habit formation; recursive contracts; new dynamic public finance;

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