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Optimal Taxation With Heterogeneous Firms

  • Rodrigo A. Cerda
  • Diego Saravia

We study steady state optimal taxation in a context where firms differ in productivity and they decide whether to produce or not after comparing after-tax profits vis-à-vis an outside alternative option. The government taxes capital income, firms’ profits and labor income, but does not tax the alternative outside option. In this context, taxation might distort the firms’ decisions to participate in production (extensive margin) as well as their factor allocations once they decide to produce (intensive margin). We find that the government has incentives to subsidize costs to induce firms into production. The optimal capital income tax is negative while the corporate tax rate is positive and the sign of labor income tax is ambiguous.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 518.

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Date of creation: Jun 2009
Date of revision:
Handle: RePEc:chb:bcchwp:518
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  1. 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.
  2. Javier Coto-Martínez & Carlos Garriga & Fernando Sánchez-Losada, 2007. "Optimal taxation with imperfect competition and aggregate returns to specialization," Working Papers 2007-036, Federal Reserve Bank of St. Louis.
  3. Yuki, Kazuhiro, 2007. "Urbanization, informal sector, and development," Journal of Development Economics, Elsevier, vol. 84(1), pages 76-103, September.
  4. Andrew B. Abel, 2005. "Optimal Taxation when Consumers Have Endogenous Benchmark Levels of Consumption," Review of Economic Studies, Oxford University Press, vol. 72(1), pages 21-42.
  5. Turnovsky, Stephen J. & Basher, Md.A., 2009. "Fiscal policy and the structure of production in a two-sector developing economy," Journal of Development Economics, Elsevier, vol. 88(2), pages 205-216, March.
  6. Andres Erosa & Martin Gervais, 2000. "Optimal taxation in life-cycle economies," Working Paper 00-02, Federal Reserve Bank of Richmond.
  7. Aiyagari, S Rao, 1995. "Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1158-75, December.
  8. Larrain, Mauricio & Poblete, Joaquin, 2007. "Age-differentiated minimum wages in developing countries," Journal of Development Economics, Elsevier, vol. 84(2), pages 777-797, November.
  9. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 383-462 National Bureau of Economic Research, Inc.
  10. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  11. Kenneth L. Judd, 1997. "The Optimal Tax Rate for Capital Income is Negative," NBER Working Papers 6004, National Bureau of Economic Research, Inc.
  12. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 485-517, June.
  13. Correia, Isabel H., 1996. "Should capital income be taxed in the steady state?," Journal of Public Economics, Elsevier, vol. 60(1), pages 147-151, April.
  14. Kenneth L. Judd, 2002. "Capital-Income Taxation with Imperfect Competition," American Economic Review, American Economic Association, vol. 92(2), pages 417-421, May.
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