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Why Tax Capital?

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  • Junsang Lee
  • Yili Chien

Abstract

We study optimal capital income taxation with a Ramsey problem and relate this optimal taxation problem to the question that has been asked in the asset pricing literature, which is why the risk free interest rate is too low. We show that the Ramsey planner chooses the optimal level of capital stock to be one that satisfies the modified golden rule in the steady state under some conditions. The conditions include suffcient government tax instruments and ability to issue bonds. We argue that the optimal capital level is different from that chosen in a competitive equilibrium unless the competitive equilibrium risk free interest rate is same as the time discount rate in the steady state. This difference in the choice of capital motivates imposing a positive capital income tax (or subsidy) on households to induce them to invest at the socially optimal amount. As examples, we investigate optimal capital taxation in a decentralized economy with limited commitment and one with private information. However, the result still holds in various types of economies with risk free interest rate that is too low.

Suggested Citation

  • Junsang Lee & Yili Chien, 2008. "Why Tax Capital?," ANU Working Papers in Economics and Econometrics 2008-497, Australian National University, College of Business and Economics, School of Economics.
    • Handle: RePEc:acb:cbeeco:2008-497
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    File URL: https://www.cbe.anu.edu.au/researchpapers/econ/wp497.pdf
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    Cited by:

    1. YiLi Chien & JunSang Lee, 2006. "Optimal Capital Taxation under Limited Commitment," 2006 Meeting Papers 430, Society for Economic Dynamics.
    2. Daniel R. Carroll & Jim Dolmas & Eric Young, 2015. "Majority Voting: A Quantitative Investigation," Working Papers (Old Series) 1442, Federal Reserve Bank of Cleveland.

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    More about this item

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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