Capital income taxation when markets are incomplete
In this paper we investigate the welfare effects of capital income taxation in a standard one commodity general equilibrium model with incomplete markets (GEI) and production. We consider a competitive economy of two periods with uncertainty over a finite number S of possible states of nature revealed in the second period. One perishable commodity is traded on (S + 1) spot markets, there are 1 1 of consumer types. Securities are equity contracts; claims on second period's returns from production plans which are selected by J firms in the interest of shareholders. The number of such contracts is insufficient to span all possible contingencies; that is we assume that the security markets are incomplete. The central planner is (uniquely) endowed with a system of ad-valorem taxes on corporate dividends. If H is not too large, there exist tax reforms that have positive welfare effects; yet, tax reforms with opposite effects do also exist. This result has implications for the theory of optimal taxation and social discounting.
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