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Optimal Capital Versus Labor Taxation with Innovation-Led Growth

  • Philippe Aghion
  • Ufuk Akcigit
  • Jesús Fernández-Villaverde

Chamley (1986) and Judd (1985) showed that, in a standard neoclassical growth model with capital accumulation and infinitely lived agents, either taxing or subsidizing capital cannot be optimal in the steady state. In this paper, we introduce innovation-led growth into the Chamley-Judd framework, using a Schumpeterian growth model where productivity-enhancing innovations result from profit-motivated R&D investment. Our main result is that, for a given required trend of public expenditure, a zero tax/subsidy on capital becomes suboptimal. In particular, the higher the level of public expenditure and the income elasticity of labor supply, the less should capital income be subsidized and the more it should be taxed. Not taxing capital implies that labor must be taxed at a higher rate. This in turn has a detrimental effect on labor supply and therefore on the market size for innovation. At the same time, for a given labor supply, taxing capital also reduces innovation incentives, so that for low levels of public expenditure and/or labor supply elasticity it becomes optimal to subsidize capital income.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19086.

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Date of creation: May 2013
Date of revision:
Handle: RePEc:nbr:nberwo:19086
Note: IO
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