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Why Tax Capital?

  • Yili Chien
  • Junsang Lee

    ()

    (UCLA public)

We study optimal capital taxation in a limited commitment environment. Our environment consists of a continuum of households with idiosyncratic labor shocks, who have access to a complete contingent claims market. Financial contracts are not perfectly enforceable; as in Kehoe and Levine (1993), enforcement constraints take the form of endogenous debt limits. This market imperfection drives the endogenous discrepancy between the household and planner discount factors: households face the possibility of being debt constrained in the future, and as a result have a higher discount factor than the planner, who does not face such a constraint. In such an economy, the planner will choose an optimal capital level that is lower than that chosen by households; this di¤erence in the choice of capital motivates imposing a positive capital income tax on households to induce them to invest at the socially optimal amount

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 492.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:492
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