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On the Optimal Taxation of Capital Income

  • Larry E. Jones
  • Rodolfo E. Manuelli
  • Peter E. Rossi

One of the best known results in modern public finance is the Chamley-Judd result showing that the optimal tax rate on capital income is zero in the long-run. In this paper, we reexamine this result by analyzing a series of generalizations of the Chamley-Judd formulation. We show that in a model with human capital, if the tax code is sufficiently rich and there are no pure profits from accumulating human capital, then all distorting taxes are zero in the long-run under the optimal plan. In this sense, income from physical capital is not special. To gain a better understanding of these two conditions, we study examples in which they are not satisfied and show that the optimal tax rate on income from physical capital does not go to zero. In those cases where the limiting tax rate is non-zero, we calculate its value for alternative specifications of the marginal welfare cost of taxation. Our results indicate that even for conservative specifications, tax rates of 10% and higher are possible under the optimal code.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4525.

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Date of creation: Nov 1993
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Publication status: published as Journal of Economic Theory, Vol. 73, no. 1 (March 1997): 93-117.
Handle: RePEc:nbr:nberwo:4525
Note: PE
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  1. Barro, R.J., 1988. "Government Spending In A Simple Model Of Endogenous Growth," RCER Working Papers 130, University of Rochester - Center for Economic Research (RCER).
  2. Sanford Grossman & Oliver Hart, . "An Analysis of the Principal-Agent Problem," Rodney L. White Center for Financial Research Working Papers 15-80, Wharton School Rodney L. White Center for Financial Research.
  3. Joseph E. Stiglitz, 1987. "Pareto Efficient and Optimal Taxation and the New New Welfare Economics," NBER Working Papers 2189, National Bureau of Economic Research, Inc.
  4. 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.
  5. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  6. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 485-517, June.
  7. 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.
  8. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
  9. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
  10. Auerbach, Alan J., 1985. "The theory of excess burden and optimal taxation," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 1, chapter 2, pages 61-127 Elsevier.
  11. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  12. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
  13. Joseph E. Stiglitz & Partha Dasgupta, 1970. "Differential Taxation, Public Goods, and Economic Efficiency," Cowles Foundation Discussion Papers 299, Cowles Foundation for Research in Economics, Yale University.
  14. Judd, Kenneth L, 1987. "The Welfare Cost of Factor Taxation in a Perfect-Foresight Model," Journal of Political Economy, University of Chicago Press, vol. 95(4), pages 675-709, August.
  15. Atkinson, A B & Sandmo, A, 1980. "Welfare Implications of the Taxation of Savings," Economic Journal, Royal Economic Society, vol. 90(359), pages 529-49, September.
  16. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
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