Dynamic Pre-distributive Capital Tax Design with Raising Skill Premium

Abstract

This paper studies optimal dynamic capital taxation under the progress of skill-biased technologyand finds a novel reason for taxing capital. We demonstrate that the optimal capital tax rate can be expressed as a function of time-invariable social welfare weights and a time-variable (a) skill premium,(b) utility elasticity of labor, and (c) Hicks elasticity of complementarity between period consumptionand leisure. While the optimal capital tax in the second period replicates Stiglitz (2018)’s finding, the optimal capital tax in the periods following the second period is quite different. It is determined bythe intertemporal changes of items (a) to (c) instead of the current values of (a) to (c). In particular, supposing that the taxpayers are labor averse and that there is complementarity between period con-sumption and leisure, the optimal capital tax is positive when the skill premium is rising. This is true even if the skill premium is not endogenous to capital input.