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Markov-perfect capital and labor taxes

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  • Martin, Fernando M.

Abstract

This paper analyzes the Markov-perfect equilibrium of an economy were a benevolent government that lacks the ability to commit to future policy choices, uses taxes on capital and labor income to finance the provision of a public good. The main finding is that the government taxes capital and subsidizes labor so that only the dynamic inefficiency of future capital taxes remains. If agents' preference for the public good is sufficiently high, then capital is confiscated. Setting bounds on taxes alleviates the dynamic inefficiency inherent in capital taxation, but some implementations carry a high welfare cost. Allowing for endogenous capital utilization makes the current capital tax distortionary and implies capital and labor tax rates that are relatively close to those measured for the U.S. economy.

Suggested Citation

  • Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
  • Handle: RePEc:eee:dyncon:v:34:y:2010:i:3:p:503-521
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    References listed on IDEAS

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    Cited by:

    1. Martin, Fernando M., 2015. "Debt, inflation and central bank independence," European Economic Review, Elsevier, vol. 79(C), pages 129-150.
    2. Novales, Alfonso & Pérez, Rafaela & Ruiz, Jesus, 2014. "Optimal time-consistent fiscal policy under endogenous growth with elastic labor supply," Economic Modelling, Elsevier, vol. 42(C), pages 398-412.
    3. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R., 2016. "Optimal capital controls and real exchange rate policies: A pecuniary externality perspective," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 147-165.
    4. Long Xin & Pelloni Alessandra, 2011. "Welfare improving taxation on savings in a growth model," wp.comunite 0091, Department of Communication, University of Teramo.
    5. George Economides & Anastasios Rizos, 2017. "Optimal taxation and the tradeoff between efficiency and redistribution," DEOS Working Papers 1701, Athens University of Economics and Business.
    6. Fernando Martin, 2009. "A Positive Theory of Government Debt," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 608-631, October.
    7. repec:eee:pubeco:v:154:y:2017:i:c:p:137-159 is not listed on IDEAS
    8. Martin, Fernando M., 2011. "On the joint determination of fiscal and monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 132-145, March.
    9. Sarolta Laczo & Raffaele Rossi, 2014. "Time-consistent consumption taxation," Working Papers 67495267, Lancaster University Management School, Economics Department.
    10. Richard Dennis, 2013. "Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive," Working Papers 2013_15, Business School - Economics, University of Glasgow.
    11. Gervais, Martin & Mennuni, Alessandro, 2015. "Optimal fiscal policy in the neoclassical growth model revisited," European Economic Review, Elsevier, vol. 73(C), pages 1-17.
    12. Nakata, Taisuke, 2016. "Optimal fiscal and monetary policy with occasionally binding zero bound constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 220-240.
    13. Novales, Alfonso & Pérez, Rafaela & Ruiz, Jesús, 2014. "Optimal time-consistent fiscal policy in an endogenous growth economy with public consumption and capital," Journal of Macroeconomics, Elsevier, vol. 42(C), pages 104-117.
    14. Fernando M. Martin, 2013. "Government Policy In Monetary Economies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 54(1), pages 185-217, February.
    15. Konstantinos Angelopoulos & Jim Malley & Apostolis Philippopoulos, 2011. "Time-consistent Fiscal Policy under Heterogeneity: Conflicting or Common Interests?," CESifo Working Paper Series 3444, CESifo Group Munich.
    16. Vasilev, Aleksandar, 2013. "Fiscal policy in a Real-Business-Cycle model with labor-intensive government services and endogenous public sector wages and hours," EconStor Preprints 142338, ZBW - German National Library of Economics.
    17. Long, Xin & Pelloni, Alessandra, 2017. "Factor income taxation in a horizontal innovation model," Journal of Public Economics, Elsevier, vol. 154(C), pages 137-159.
    18. Malte Rieth, 2017. "Capital Taxation and Government Debt Policy with Public Discounting," Discussion Papers of DIW Berlin 1697, DIW Berlin, German Institute for Economic Research.
    19. Martin, Fernando M., 2015. "Policy And Welfare Effects Of Within-Period Commitment," Macroeconomic Dynamics, Cambridge University Press, vol. 19(07), pages 1401-1426, October.
    20. Chien, YiLi & Lee, Junsang, 2016. "Optimal Ramsey Capital Taxation with Endogenous Government Spending," Review, Federal Reserve Bank of St. Louis, vol. 98(4), pages 311-327.
    21. repec:eee:dyncon:v:85:y:2017:i:c:p:1-20 is not listed on IDEAS
    22. Occhino Filippo, 2012. "Government Debt Dynamics Under Discretion," The B.E. Journal of Macroeconomics, De Gruyter, vol. 12(1), pages 1-28, July.
    23. Marina Azzimonti, 2016. "The Politics of FDI Expropriation," NBER Working Papers 22705, National Bureau of Economic Research, Inc.

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