Incidence of Capital Income Taxation in a Lifecycle Economy with Firm Heterogeneity

Abstract

We study the incidence of capital income taxation in a dynamic general equilibrium model with heterogeneous firms and lifecycle households. In this incomplete market setting, marginal excess burdens of three capital taxes, namely corporate income, dividend and capital gains taxes, are vastly different due to heterogeneous responses of firms and households, and heterogeneous effects of general equilibrium adjustments. Overall, taxing capital with a corporate income tax at the firm level results in higher excess burden than taxing capital with dividend and capital gains taxes at the household level. Given the salient features of the 2013 U.S. tax system, reforms that shift tax burden from the firm to household side potentially result in aggregate efficiency gains and overall welfare improving. However, the welfare benefits of these tax reforms are quite different across households and generations over transition, depending on skill type, age-cohort and government budget balancing rule. Thus, our findings highlight the importance of accounting for firm and household heterogeneity when analyzing the aggregate and distributional effects of capital income taxation.