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Optimal Capital Taxation Under Limited Commitment

  • Yili Chien

    ()

  • Junsang Lee

    ()

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.

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Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2009-06.

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Length: 30 pages
Date of creation: Jan 2009
Date of revision:
Handle: RePEc:een:camaaa:2009-06
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