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Optimal Capital Taxation under Limited Commitment

  • YiLi Chien

    ()

    (Economics UCLA)

  • JunSang Lee

We study optimal capital taxation under limited commitment. We prove that the optimal tax rate on capital income should be positive in steady state and should be increasing over time provided that full risk-sharing is not feasible. In a limited commitment environment, a one unit increase of capital investment by an agent increases all individualsÂ’ autarky values in the economy and generates externality costs in the economy. This externality cost provides a rationale for positive capital taxation even in the absence of government expenditure. Moreover, we show that both this externality cost of capital investment and the optimal tax rate are potentially much bigger than one might expect

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 430.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:430
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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