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Pareto-Improving Optimal Capital and Labor Taxes

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  • Katharina Greulich
  • Sarolta Laczó
  • Albert Marcet

Abstract

We study optimal Pareto-improving fiscal policy in a model where agents are heterogeneous in their labor productivity and wealth and markets are complete. We first argue that recent results that find positive long-run capital taxes in the Ramsey equilibrium in standard models obtain for special parameter values. If the government is prevented from immiserating future generations the Chamley-Judd result reemerges. In addition, we question the traditional focus on long-run taxes. We show that a gradual reform is crucial: labor taxes should be cut and capital taxes should remain high for a very long time in order to achieve a Pareto improvement. Therefore, the long-run optimal tax mix is the opposite of the short- and medium-run one. The length of the transition determines who benefits more from the tax reform. The initial labor tax cut causes early deficits which lead to a positive level of government debt in the long run. Further, we show that a Benthamite policy (equal weights for all agents) is often not Pareto improving, and that, given significant heterogeneity, the optimal fiscal policy is time-consistent if a Pareto improvement is required at the time of reoptimization. We address a number of technical issues: sufficiency of first-order conditions for the Ramsey optimum, asymptotic behavior, and solution algorithms.

Suggested Citation

  • Katharina Greulich & Sarolta Laczó & Albert Marcet, 2016. "Pareto-Improving Optimal Capital and Labor Taxes," Working Papers 887, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:887
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    References listed on IDEAS

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    Cited by:

    1. Konstantinos Angelopoulos & James Malley & Apostolis Philippopoulos, 2011. "Time-consistent fiscal policy under heterogeneity: Conflicting or common interests?," Working Papers 2011_06, Business School - Economics, University of Glasgow.
    2. Konstantinos Angelopoulos & Jim Malley & Apostolis Philippopoulos, 2011. "Time-consistent Fiscal Policy under Heterogeneity: Conflicting or Common Interests?," CESifo Working Paper Series 3444, CESifo.
    3. Juan Carlos Conesa & Begona Dominguez, 2020. "Capital Taxes and Redistribution: The Role of Management Time and Tax Deductible Investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 156-172, July.
    4. Röhrs, Sigrid & Winter, Christoph, 2017. "Reducing government debt in the presence of inequality," Journal of Economic Dynamics and Control, Elsevier, vol. 82(C), pages 1-20.
    5. Sofía Bauducco, 2011. "Seigniorage and Distortionary Taxation in a Model with Heterogeneous Agents and Idiosyncratic Uncertainty," Working Papers Central Bank of Chile 611, Central Bank of Chile.
    6. Tobon Orozco, David & Molina Guerra, Carlos & Vargas Cano, John Harvey, 2016. "Extent of Expected Pigouvian Taxes and Permits for Environmental Services in a General Equilibrium Model with a natural capital constraint," Borradores Departamento de Economía 015258, Universidad de Antioquia - CIE.
    7. Juan Carlos Conesa & Begona Dominguez, 2020. "Capital Taxes and Redistribution: The Role of Management Time and Tax Deductible Investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 156-172, July.
    8. V. V. Chari & Juan Pablo Nicolini & Pedro Teles, 2018. "Optimal Capital Taxation Revisited," Working Papers 752, Federal Reserve Bank of Minneapolis, revised 06 Jul 2018.
    9. Xavier Ragot & Francois Le Grand, 2017. "Optimal Fiscal Policy with Heterogeneous Agents and Aggregate Shocks," 2017 Meeting Papers 969, Society for Economic Dynamics.
    10. Ferrara, Maria & Tirelli, Patrizio, 2017. "Equitable fiscal consolidations," Economic Modelling, Elsevier, vol. 61(C), pages 207-223.
    11. Roberta, Cardani & Lorenzo, Menna & Patrizio, Tirelli, 2016. "Optimal Public Debt Consolidation with Distributional Conflicts," Working Papers 350, University of Milano-Bicocca, Department of Economics, revised 05 Oct 2016.

    More about this item

    Keywords

    fiscal policy; Pareto-improving tax reform; redistribution;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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