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Capital Taxation, Intermediate Goods, and Production Efficiency

An important controversy in public finance is whether long-run capital taxes are optimally zero or not, with a broad variety of models supporting each case. This paper examines the question whether capital is special and if so, what the underlying principle could be that explains both types of results. I find that capital is provided without distortions in a wide class of models, i.e. that its marginal product is the same in first and second best. The conditions for this to hold are that the government is able to tax all of capital's co-factors of production separately and that capital does not enter the utility function. When individually rational behavior leads to sub-optimal capital accumulation, then capital taxes are used to implement the optimal allocation. The intuition is that capital is an intermediate good; optimal taxation seeks to tax endowments and intermediate goods do not have any endowment component.

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Paper provided by Carleton University, Department of Economics in its series Carleton Economic Papers with number 13-09.

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Length: 36 pages
Date of creation: 23 Oct 2013
Date of revision:
Publication status: Published: Carleton Economic Papers
Handle: RePEc:car:carecp:13-09
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  1. Stefania Albanesi, 2006. "Optimal Taxation of Entrepreneurial Capital with Private Information," NBER Working Papers 12419, National Bureau of Economic Research, Inc.
  2. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2009. "Taxing Capital? Not a Bad Idea after All!," American Economic Review, American Economic Association, vol. 99(1), pages 25-48, March.
  3. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. N. Gregory Mankiw & Matthew Weinzierl & Danny Yagan, 2009. "Optimal Taxation in Theory and Practice," Journal of Economic Perspectives, American Economic Association, vol. 23(4), pages 147-74, Fall.
  5. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, June.
  6. Peter A. Diamond & Emmanuel Saez, 2011. "The Case for a Progressive Tax: From Basic Research to Policy Recommendations," CESifo Working Paper Series 3548, CESifo Group Munich.
  7. Stefania Albanesi & Roc Armenter, 2012. "Intertemporal Distortions in the Second Best," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1271-1307.
  8. Armenter, Roc, 2008. "A note on incomplete factor taxation," Journal of Public Economics, Elsevier, vol. 92(10-11), pages 2275-2281, October.
  9. Emmanuel Farhi, 2007. "Capital Taxation and Ownership when Markets are Incomplete," NBER Working Papers 13390, National Bureau of Economic Research, Inc.
  10. Chamley, Christophe, 2001. "Capital income taxation, wealth distribution and borrowing constraints," Journal of Public Economics, Elsevier, vol. 79(1), pages 55-69, January.
  11. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  12. Erosa, Andres & Gervais, Martin, 2002. "Optimal Taxation in Life-Cycle Economies," Journal of Economic Theory, Elsevier, vol. 105(2), pages 338-369, August.
  13. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
  14. David Domeij, 2005. "Optimal Capital Taxation and Labor Market Search," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(3), pages 623-650, July.
  15. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production II: Tax Rules," American Economic Review, American Economic Association, vol. 61(3), pages 261-78, June.
  16. Correia, Isabel H., 1996. "Dynamic optimal taxation in small open economies," Journal of Economic Dynamics and Control, Elsevier, vol. 20(4), pages 691-708, April.
  17. Till Gross, 2013. "Dynamic Optimal Taxation in Open Economies," Carleton Economic Papers 13-06, Carleton University, Department of Economics.
  18. Munk, Knud Jorgen, 1980. "Optimal Taxation with Some Non-Taxable Commodities," Review of Economic Studies, Wiley Blackwell, vol. 47(4), pages 755-65, July.
  19. Brecher, Richard A. & Chen, Zhiqi & Choudhri, Ehsan U., 2010. "A dynamic model of shirking and unemployment: Private saving, public debt, and optimal taxation," Journal of Economic Dynamics and Control, Elsevier, vol. 34(8), pages 1392-1402, August.
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