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Second-Best Optimal Taxation of Capital and Labor in a Developing Economy

This paper examines how the tax burden in a developing economy should be distributed between capital income and labor income. We study a two-sector model, where the traditional sector is "informal" and consequently cannot be taxed by the government. In this set up, we find that the optimal (second-best) tax structure in order to raise a certain amount of revenue requires to tax capital income at least as much as labor income, and possibly more.

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Paper provided by Institut d'economie publique (IDEP), Marseille, France in its series IDEP Working Papers with number 0307.

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Length: 35 pages
Date of creation: May 2003
Date of revision:
Handle: RePEc:iep:wpidep:0307
Contact details of provider: Postal: 2, rue de la Charité 13002 Marseille
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  1. Joseph E. Stiglitz, 1967. "Distribution of Income and Wealth Among Individuals," Cowles Foundation Discussion Papers 238, Cowles Foundation for Research in Economics, Yale University.
  2. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  3. Koskela, Erkki & Schob, Ronnie, 2002. " Optimal Factor Income Taxation in the Presence of Unemployment," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 4(3), pages 387-404.
  4. Deaton, Angus, 1981. "Optimal Taxes and the Structure of Preferences," Econometrica, Econometric Society, vol. 49(5), pages 1245-60, September.
  5. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Larry E. Jones & Rodolfo E. Manuelli & Peter E. Rossi, 1993. "On the Optimal Taxation of Capital Income," NBER Working Papers 4525, National Bureau of Economic Research, Inc.
  7. Kevin J. Lansing, 1998. "Optimal redistributive capital taxation in a neoclassical growth model," Working Papers in Applied Economic Theory 99-01, Federal Reserve Bank of San Francisco.
  8. Turnovsky, Stephen J., 1996. "Optimal tax, debt, and expenditure policies in a growing economy," Journal of Public Economics, Elsevier, vol. 60(1), pages 21-44, April.
  9. Maurice Obstfeld, 1992. "Risk-Taking, Global Diversification, and Growth," NBER Working Papers 4093, National Bureau of Economic Research, Inc.
  10. Fuest, Clemens & Huber, Bernd, 2001. "Labor and capital income taxation, fiscal competition, and the distribution of wealth," Munich Reprints in Economics 20294, University of Munich, Department of Economics.
  11. Tanzi, Vito & Zee, Howell H., 2000. "Tax Policy for Emerging Markets: Developing Countries," National Tax Journal, National Tax Association, vol. 53(n. 2), pages 299-322, June.
  12. CREMER, Helmuth & PESTIEAU, Pierre & ROCHET, Jean-Charles, . "Capital income taxation when inherited wealth is not observable," CORE Discussion Papers RP 1700, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  13. Chamley, Christophe, 2001. "Capital income taxation, wealth distribution and borrowing constraints," Journal of Public Economics, Elsevier, vol. 79(1), pages 55-69, January.
  14. Cecilia Garcia-Penalosa & Stephen Turnovsky, 2003. "Production Risk and the Functional Distribution of Income in a Developing Economy: Tradeoffs and Policy Responses," Working Papers UWEC-2002-07-P, University of Washington, Department of Economics, revised Oct 2003.
  15. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
  16. Kormendi, Roger C. & Meguire, Philip G., 1985. "Macroeconomic determinants of growth: Cross-country evidence," Journal of Monetary Economics, Elsevier, vol. 16(2), pages 141-163, September.
  17. 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.
  18. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  19. Stephen Turnovsky, 1998. "Fiscal Policy, Elastic Labor Supply, and Endogenous Growth," Discussion Papers in Economics at the University of Washington 0068, Department of Economics at the University of Washington.
  20. Aghion, Philippe & Caroli, Eve & García-Peñalosa, Cecilia, 1999. "Inequality and Economic Growth: The Perspective of the New Growth Theories," Scholarly Articles 12502063, Harvard University Department of Economics.
  21. Skoufias, Emmanuel, 1996. "Intertemporal substitution in labor supply: Micro evidence from rural India," Journal of Development Economics, Elsevier, vol. 51(2), pages 217-237, December.
  22. Stephen J. Turnovsky, 2000. "Methods of Macroeconomic Dynamics, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262201232, June.
  23. Chamley, Christophe, 1985. "Efficient Taxation in a Stylized Model of Intertemporal General Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 451-68, June.
  24. Bertola, Giuseppe, 1991. "Factor Shares and Savings In Endogenous Growth," CEPR Discussion Papers 576, C.E.P.R. Discussion Papers.
  25. Deininger, K & Squire, L, 1996. "Measuring Income Inequality : A New Data-Base," Papers 537, Harvard - Institute for International Development.
  26. Dessy, Sylvain & Pallage, Stéphane, 2001. "Taxes, Inequality and the Size of the Informal Sector," Cahiers de recherche 0112, Université Laval - Département d'économique.
  27. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, vol. 66(2), pages 293-312, November.
  28. Edward N. Wolff, 1998. "Recent Trends in the Size Distribution of Household Wealth," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 131-150, Summer.
  29. Futagami, Koichi & Morita, Yuichi & Shibata, Akihisa, 1993. " Dynamic Analysis of an Endogenous Growth Model with Public Capital," Scandinavian Journal of Economics, Wiley Blackwell, vol. 95(4), pages 607-25, December.
  30. Judd, Kenneth L., 1999. "Optimal taxation and spending in general competitive growth models," Journal of Public Economics, Elsevier, vol. 71(1), pages 1-26, January.
  31. repec:cup:cbooks:9780521265638 is not listed on IDEAS
  32. repec:cup:cbooks:9780521397421 is not listed on IDEAS
  33. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-37, October.
  34. Jane Ihrig & Karine S. Moe, 2000. "The dynamics of informal employment," International Finance Discussion Papers 664, Board of Governors of the Federal Reserve System (U.S.).
  35. Bourguignon, Francois, 1981. "Pareto Superiority of Unegalitarian Equilibria in Stiglitz' Model of Wealth Distribution with Convex Saving Function," Econometrica, Econometric Society, vol. 49(6), pages 1469-75, November.
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