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Optimal Taxation with Commitment in a Two-sector Neoclassical Economy

  • Sheikh Selim

    (University of Southampton)

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    This paper examines dynamic optimal income taxation problem in a two- sector neoclassical model where the government is able to commit to a sequence of tax plans for future. It finds that (1) while it is optimal to set a zero long run capital tax for the capital goods sector, steady state optimal capital tax can be nonzero in the consumption goods sector; (2) if the government faces an ex ante constraint of setting equal factor income taxes, the optimal levels of both capital tax rates are nonzero. The distortion created by the nonzero capital tax in consumption goods sector, given the other capital tax is set at zero, is in no way explosive in nature, since economic agents can avoid the compounding tax liabilities simply by shifting depreciated capital.

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    File URL: http://econwpa.repec.org/eps/mac/papers/0502/0502027.pdf
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    Paper provided by EconWPA in its series Macroeconomics with number 0502027.

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    Length: 38 pages
    Date of creation: 21 Feb 2005
    Date of revision:
    Handle: RePEc:wpa:wuwpma:0502027
    Note: Type of Document - pdf; pages: 38
    Contact details of provider: Web page: http://econwpa.repec.org

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