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Determining the motives for a positive optimal tax on capital

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  • William B. Peterman

Abstract

Previous literature demonstrates that in a computational life cycle model the optimal tax on capital is positive and large. Given the computational complexities of these overlapping generations models it is helpful to determine the relative importance of the economic factors driving this result. I highlight the impact of changing two common assumptions in a benchmark model that generates a large optimal tax on capital similar to the model in Conesa et al. (2009). First, the utility function is altered such that it implies an agent's Frisch labor supply elasticity is constant, as opposed to increasing, over his lifetime. Second, the government is allowed to tax accidental bequests at a separate rate from ordinary capital income. The main finding of this paper is that these two changes cause the optimal tax on capital to drop by almost half. Furthermore, I find that the welfare costs of adopting the high optimal tax on capital from the benchmark model in the model with the altered assumptions, which calls for a lower tax on capital, are equivalent to 0.35 percent of total lifetime consumption. Quantifying the impact of these assumptions in the benchmark model is important because the first has limited empirical evidence and the second, although included for tractability, confounds a motive for taxing capital with a motive for taxing accidental bequests.

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  • William B. Peterman, 2011. "Determining the motives for a positive optimal tax on capital," Finance and Economics Discussion Series 2011-55, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2011-55
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    References listed on IDEAS

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    Cited by:

    1. Fehr, Hans & Kindermann, Fabian, 2015. "Taxing capital along the transition—Not a bad idea after all?," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 64-77.
    2. Peterman, William B., 2013. "Determining the motives for a positive optimal tax on capital," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 265-295.
    3. Krueger, D. & Mitman, K. & Perri, F., 2016. "Macroeconomics and Household Heterogeneity," Handbook of Macroeconomics, Elsevier.
    4. William Peterman, 2016. "The effect of endogenous human capital accumulation on optimal taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 21, pages 46-71, July.
    5. repec:red:issued:16-217 is not listed on IDEAS
    6. Cassou, Steven P. & Gorostiaga, Arantza & Uribe-Zubiaga, Iker, 2013. "Policy effects of the elasticity of substitution across labor types in life cycle models," Economic Modelling, Elsevier, vol. 35(C), pages 59-70.
    7. William B. Peterman, 2012. "An extensive look at taxes: how does endogenous retirement affect optimal taxation?," Finance and Economics Discussion Series 2012-28, Board of Governors of the Federal Reserve System (U.S.).
    8. repec:eee:hapoch:v1_713 is not listed on IDEAS
    9. Stephie Fried & Kevin Novan & William Peterman, 2018. "The Distributional Effects of a Carbon Tax on Current and Future Generations," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 30, pages 30-46, October.

    More about this item

    Keywords

    Capital ; Taxation;

    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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