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Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting

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  • Aiyagari, S Rao

Abstract

For a wide class of infinitely lived agent models, Christophe Chamley (1986) has shown that the optimal capital income tax rate is zero in the long run. Robert E. Lucas (1990) has argued that, for the U.S. economy, there is a significant welfare gain from switching to this policy. This paper shows that, for the Bewley class of models with incomplete insurance markets and borrowing constraints, the optimal tax rate on capital income is positive, even in the long run. Therefore, cutting the capital income tax to zero may well lead to welfare losses. Copyright 1995 by University of Chicago Press.

Suggested Citation

  • Aiyagari, S Rao, 1995. "Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1158-1175, December.
  • Handle: RePEc:ucp:jpolec:v:103:y:1995:i:6:p:1158-75
    DOI: 10.1086/601445
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    1. Judd, Kenneth L., 1985. "The law of large numbers with a continuum of IID random variables," Journal of Economic Theory, Elsevier, vol. 35(1), pages 19-25, February.
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    4. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
    5. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
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