Abstract
The empirical tax rate on capital income ranges between 0.4 and 0.6 in OECD countries. This paper presents the optimal taxation problem in an one-sector dynamic general equilibrium model where the government is confronted with fiscal constraint (the ratio of government expenditure to GDP is exogenously given) while households and firms do not recognize the fiscal constraint. We derive analytically the positive optimal tax rates on capital income. Under the fiscal constraint, the optimal tax rate on capital income depends on the discount rate, the rate of capital depreciation, and the ratio of government spending to GDP. Our model can generate the country-specific optimal tax rate on capital income (0.2 to 0.4). Thus, this paper insists that the empirical data of tax rates in OECD countries are higher than the results predicted by our model.
Highlights
This paper presents the optimal taxation problem in an one-sector dynamic general equilibrium model where the government is confronted with fiscal constraint while households and firms do not recognize the fiscal constraint
Just as endogenous growth models attempt to explain the differences in the rate of economic growth, we require a new model to explain the differences in the tax rate on capital income in each country
Denote the competitive equilibrium solution by (CE); 2) By solving the differential equation of budget constraints of households at each time, we can obtain an intertemporal budget constraint of the households expressed in terms of present value; 3) By substituting the first-order conditions of households into the intertemporal budget constraint of households, the implementability condition is obtained; 4) By using the first-order condition from the profit maximization of the firms and their Euler’s Theorem and nonarbitrage condition, the budget constraint of the government and the households can reduce to the simple resource constraint; 5) The government maximizes the social welfare function subject to the resource constraints and the implementability condition
Summary
Just as endogenous growth models attempt to explain the differences in the rate of economic growth, we require a new model to explain the differences in the tax rate on capital income in each country. Chamley (1986) [1] shows that the optimal tax rate on capital income becomes eventually zero at a steady state in an one-sector dynamic general equilibrium model. We derive the positive optimal tax rate on capital income This result from our model depends only on the discount rate, the rate of capital depreciation, and the exogenous ratio of government spending to GDP. The empirical tax rate on capital income in OECD data is higher than the theoretical optimal tax rate predicted by our model. Japan Korea Luxembourg Netherlands Norway Spain Sweden United Kingdom United States
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