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Capital Taxation with Entrepreneurial Risk

  • Vasia Panousi

    (MIT)

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    This paper studies the effects of capital taxation in a dynamic heterogeneous-agent economy with uninsurable entrepreneurial risk. Although it allows for rich general-equilibrium effects and a stationary distribution of wealth, the model is highly tractable. This permits a clear analysis, not only of the steady state, but also of the entire transitional dynamics following any change in tax policies. Unlike either the complete-markets paradigm or Bewley-type models where idiosyncratic risk impacts only labor income, here it is shown that capital taxation may actually stimulate capital accumulation. This possibility emerges because of the general-equilibrium effects of the insurance aspect of capital taxation. In particular, for the preferred calibrated version of the model, when the tax on capital is 25%, aggregate output is 2.5% higher than what it would have been had the tax rate been zero. Turning to the welfare effects of a reform in capital taxation, it is shown how these effects depend on whether one focuses on the steady state or also takes into account transitional dynamics, as well as how they vary in the cross-section of the population (rich versus poor, entrepreneurs versus non-entrepreneurs).

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    File URL: https://economicdynamics.org/meetpapers/2008/paper_36.pdf
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    Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 36.

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    Date of creation: 2008
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    Handle: RePEc:red:sed008:36
    Contact details of provider: Postal:
    Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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