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Taxing capital is a good idea: the role of idiosyncratic risk in an OLG model

  • Ryoji Hiraguchi


    (Faculty of Economics, Ritsumeikan University)

  • Akihisa Shibata


    (Institute of Economic Research, Kyoto University)

We investigate an overlapping generations model (OLG) model in which agents who live for two periods receive idiosyncratic productivity shocks when they are old. We show that a combination of lump-sum and linear capital taxes can always Pareto-improve the allocation, that is, it can raise the equilibrium welfare of one generation without affecting that of the others. As D?vila et al. (Econometrica (2012)) show, a capital reduction in one period raises the welfare levels of agents who are old in that period, but lowers that of the young agents, because it reduces their wages. We show that the government can compensate for these wage losses by additionally taxing the old agents, such that their welfare gains remain positive.

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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 853.

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Length: 20pages
Date of creation: Mar 2013
Date of revision:
Handle: RePEc:kyo:wpaper:853
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  1. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2007. "Taxing Capital? Not a Bad Idea After All!," NBER Working Papers 12880, National Bureau of Economic Research, Inc.
  2. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
  3. S. Rao Aiyagari, 1994. "Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting," Working Papers 508, Federal Reserve Bank of Minneapolis.
  4. DAVILA, Julio, . "The taxation of capital returns in overlapping generations models," CORE Discussion Papers RP 2397, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Chari, V.V. & Kehoe, Patrick J., 1999. "Optimal fiscal and monetary policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745 Elsevier.
  6. DAVILA, Julio & HONG, Jay H. & KRUSELL, Per & RIOS-RULL, José-Victor, . "Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks," CORE Discussion Papers RP 2463, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  7. Kenneth L. Judd, 1984. "The Welfare Cost of Factor Taxation in a Perfect Foresight Model," Discussion Papers 643, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  8. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  9. Andrés Erosa & Martin Gervais, 1998. "Optimal Taxation in Life-Cycle Economies," UWO Department of Economics Working Papers 9812, University of Western Ontario, Department of Economics.
  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. Fiorini, Luciana C., 2008. "Overlapping generations and idiosyncratic risk: Can prices reveal the best policy?," Journal of Mathematical Economics, Elsevier, vol. 44(12), pages 1312-1320, December.
  12. Ihori, Toshihiro, 1978. "The Golden Rule and the Role of Government in a Life Cycle Growth Model," American Economic Review, American Economic Association, vol. 68(3), pages 389-96, June.
  13. Andrew Atkeson & V. V. Chari & Patrick J. Kehoe, 1999. "Taxing capital income: a bad idea," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-17.
  14. Carvajal, Andrés & Polemarchakis, Herakles, 2011. "Idiosyncratic risk and financial policy," Journal of Economic Theory, Elsevier, vol. 146(4), pages 1569-1597, July.
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