Pareto efficient taxation and expenditures: Pre- and re-distribution

This paper shows that there is a presumption that Pareto-efficient taxation entails a positive tax on capital. When tax and expenditure policies can affect the market distribution of income in ways that cannot be directly offset, those effects need to be taken into account, reducing the burden imposed on distortionary redistribution. The paper extends the 1976 Atkinson-Stiglitz results to a dynamic, overlapping generations model, correcting a misreading of the result on the desirability of a zero capital tax. That result required separability of consumption from labor and that the only unobservable differences among individuals were in (fixed) labor productivities. In a general equilibrium model, one needs to take into account the effects of policy changes on binding self-selection constraints. In a simple model with time separability but with non-separability between consumption and leisure, capital taxation depends on the complementarity/substitutability of leisure during work with retirement consumption.