Organizational capital and optimal Ramsey taxation

Abstract

Many recent studies have argued that it is useful to introduce a third input into the neoclassical production technology which encapsulates the productivity enhancing knowledge created in the process of production. This input, often called organizational capital, has been shown to improve the predictions of dynamic general equilibrium models, especially at the business cycle frequency. In this paper, we study the impact of organizational capital on optimal taxation in the Ramsey tradition and find that the planner would behave quite differently in the presence of organizational capital than in its absence. We use simulations to show that the optimal capital income tax is different from zero in environments where earlier models predicted zero taxes or even subsidies. In the model, both capital and labor taxes distort the accumulation of organizational capital and the planner must trade off these dynamic distortions to fund the obligations of the government. As a result, the planner chooses a positive tax on labor and capital. Generally the tax on labor income is lower while that on capital income is higher than predicted in the absence of organizational capital.