Privatization, public investment, and capital income taxation

Abstract

This paper investigates the optimal line of demarcation between the public and private production sectors, as affected by the government’s privatization decision. Only the private sector is subject to taxation in the form of investment taxes. In deciding on privatization, the government trades off the tax distortion affecting private production against the relative production inefficiency of public production. At the optimum, the public sector is ‘too large’ in the sense that the government carries out some production activities where it is inefficient relative to the private sector. Also, public production is relatively capital-intensive.