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Optimal Capital Taxation under Limited Commitment

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  • YiLi Chien

    () (Economics UCLA)

  • JunSang Lee

Abstract

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

Suggested Citation

  • YiLi Chien & JunSang Lee, 2006. "Optimal Capital Taxation under Limited Commitment," 2006 Meeting Papers 430, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:430
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    Cited by:

    1. Yili Chien & Junsang Lee, 2006. "Why Tax Capital?," 2006 Meeting Papers 492, Society for Economic Dynamics.
    2. Kurmann, André, 2014. "Holdups and overinvestment in capital markets," Journal of Economic Theory, Elsevier, vol. 151(C), pages 88-113.

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    More about this item

    Keywords

    Optimal fiscal policy; limited enforcement;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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