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Second-Best Optimal Taxation of Capital and Labor in a Developing Economy

  • Cecilia Garcia-Penalosa
  • Stephen Turnovsky

This paper examines how the tax burden in a developing economy should be distributed between capital income and labor income. We study a two-sector model, where the traditional sector is "informal" and consequently cannot be taxed by the government. In this set up, we find that the optimal (second-best) tax structure in order to raise a certain amount of revenue requires to tax capital income at least as much as labor income, and possibly more.

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Paper provided by University of Washington, Department of Economics in its series Working Papers with number UWEC-2004-05-P.

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Date of creation: Apr 2004
Date of revision: Apr 2004
Publication status: Published in Journal of Public Economics, Volume 89,205,1045-1074
Handle: RePEc:udb:wpaper:uwec-2004-05-p
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  1. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
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  18. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  29. Chamley, Christophe, 2001. "Capital income taxation, wealth distribution and borrowing constraints," Journal of Public Economics, Elsevier, vol. 79(1), pages 55-69, January.
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  35. Deininger, K & Squire, L, 1996. "Measuring Income Inequality : A New Data-Base," Papers 537, Harvard - Institute for International Development.
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