Tax Policies, Vintage Capital, and Entry and Exit of Plants

Over the years, optimal taxation has been extensively discussed, and a major focus has been on the question of whether the optimal capital income tax rate is zero in long-run equilibrium. This paper addresses this issue in the context of a model of vintage capital with technical change and the entry and exit of new plants. It considers the optimal combinations of three taxes, including taxes on capital income, labor income, and property. The tax base for the property tax is plant value, which is determined by the plant’s productivity. Each plant is endowed with one unit of capital, which cannot be replaced or upgraded during the plant’s lifetime, although plant productivity is a combination of the vintage of capital and learning by doing. The tax base for the property tax is relatively large compared to that for capital income. There is a trade-off between these two rates in that a much lower tax rate on property is needed to satisfy a given level of government expenditure, while on the other hand the property tax rate has an effect on the exit threshold of plants and hence on the distribution of plant productivity. In this model there are two types of plants. One type is complete and able to produce the final good, while the other type is under development process and subject to a time-to-build constraint. Only the producing plant is subject to the property tax. In the steady state this paper documents interesting interactions between the capital income tax and the property tax. One special case of interest is the optimal capital income tax rate given different level of exogenous government expenditure when the property tax rate is fixed at zero. (Government expenditure is assumed to be unproductive.) Subsidies on capital income and property are considered. In addition to looking at the steady state, transitional paths including exit and entry rates of plants, and social welfare, are derived under two situations, one in which there is a shock to embodied technology, and one in which there is a shock to the path of exogenous government expenditures. Some results to date indicate that for a large range of values the steady state optimal tax rates include a positive tax on property matched with a subsidy to capital income