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Optimal capital taxation and consumer uncertainty

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  • Chahrour, Ryan
  • Svec, Justin

Abstract

This paper analyzes the impact of consumer uncertainty on optimal fiscal policy in a model with capital. The consumers lack confidence about the probability model that characterizes the stochastic environment and so apply a max–min operator to their optimization problem. An altruistic fiscal authority does not face this Knightian uncertainty. We show analytically that, in responding to consumer uncertainty, the government no longer sets the expected capital tax rate exactly equal to zero, as is the case in the full-confidence benchmark model. Rather, our numerical results indicate that the government chooses to subsidize capital income, albeit at a modest rate. We also show that the government responds to consumer uncertainty by smoothing the labor tax across states and by making the labor tax persistent.

Suggested Citation

  • Chahrour, Ryan & Svec, Justin, 2014. "Optimal capital taxation and consumer uncertainty," Journal of Macroeconomics, Elsevier, vol. 41(C), pages 178-198.
  • Handle: RePEc:eee:jmacro:v:41:y:2014:i:c:p:178-198
    DOI: 10.1016/j.jmacro.2014.06.001
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    Cited by:

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    2. Svec, Justin, 2012. "Optimal fiscal policy with robust control," Journal of Economic Dynamics and Control, Elsevier, vol. 36(3), pages 349-368.

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    More about this item

    Keywords

    Model uncertainty; Capital tax; Public debt;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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