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Optimal Capital Taxation Under Limited Commitment

  • Junsang Lee


  • Yili Chien


We study optimal capital taxation under limited commitment. We prove that the optimal tax rate on capital income should be positive in steady state provided that full risk-sharing is not feasible. In a limited commitment environment, a one unit increase of capital investment by an agent increases all individuals' autarky values in the economy and generates externality costs in the economy. This externality cost provides a rationale for positive capital taxation even in the absence of government expenditure. Moreover, we show that both this externality cost of capital investment and the optimal tax rate are potentially much bigger than one might expect.

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Paper provided by Australian National University, College of Business and Economics, School of Economics in its series ANU Working Papers in Economics and Econometrics with number 2008-498.

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Length: 31 Pages
Date of creation: Aug 2008
Date of revision:
Handle: RePEc:acb:cbeeco:2008-498
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