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Optimal Capital Taxation Under Limited Commitment

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  • Junsang Lee

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  • Yili Chien

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Abstract

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.

Suggested Citation

  • Junsang Lee & Yili Chien, 2008. "Optimal Capital Taxation Under Limited Commitment," ANU Working Papers in Economics and Econometrics 2008-498, Australian National University, College of Business and Economics, School of Economics.
  • Handle: RePEc:acb:cbeeco:2008-498
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    File URL: https://www.cbe.anu.edu.au/researchpapers/econ/wp498.pdf
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    References listed on IDEAS

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    Cited by:

    1. Yili Chien & Junsang Lee, 2006. "Why Tax Capital?," 2006 Meeting Papers 492, Society for Economic Dynamics.
    2. Kurmann, André, 2014. "Holdups and overinvestment in capital markets," Journal of Economic Theory, Elsevier, vol. 151(C), pages 88-113.

    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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