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Capital Income Taxation and the Sustainability of Permanent Primary Deficits

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  • Uhlig, H.F.H.V.S.

    (Tilburg University, Center For Economic Research)

Abstract

If a government imposes a tax on capital income, it may, as a result, lower the private rate of return on capital below the growth rate of an economy, thereby giving rise to the possibility of running a permanent deficit. Since, however, the before-tax rate of return and not the after-tax rate of return is relevant for judging the dynamical efficiency of the economy, the possibility of a permanent deficit does not by itself imply a possibility for a Pareto-improving redistribution of income. To examine this issue "step by step", we examine in general whether a government can run a deficit forever by rolling over its debt. Assuming the government to run a deficit in each period equal to a constant fraction of total output, we study several overlapping generations models, proceeding from endowment economies to neoclassical growth with a variable capital stock. We then introduce capital income taxation and show, for example, that permanent defcits are feasible in the case of a variable capital stock, provided the capital income tax is sufficiently high. We examine the welfare effects and discuss policy consequences.

Suggested Citation

  • Uhlig, H.F.H.V.S., 1997. "Capital Income Taxation and the Sustainability of Permanent Primary Deficits," Discussion Paper 1997-11, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:c1ae3c26-2aab-4f49-9c3d-845eda2c3110
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    References listed on IDEAS

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    1. A. Lans Bovenberg, 1992. "Residence-and source-based taxation of capital income in an overlapping generations model," Journal of Economics, Springer, vol. 56(3), pages 267-295, October.
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    18. Uhlig, Harald & Yanagawa, Noriyuki, 1996. "Increasing the capital income tax may lead to faster growth," European Economic Review, Elsevier, vol. 40(8), pages 1521-1540, November.
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    Keywords

    income tax; deficit spending;

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