Capital Income Tax Research Articles

Optimal climate and fiscal policy in an OLG economy

AbstractThis paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations (OLGs). I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive OLGs). In contrast to deterministic infinitely lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age‐dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.

Income sources, cyclical behaviors of fiscal policy, and welfare conflict

AbstractThis paper explores the effect of fiscal policy on the welfare of heterogeneous agents with different income sources over the business cycle. Policy experiments allow the government to choose the cyclical properties of fiscal policy instruments conditional on long-run levels to separately maximize the welfare of entrepreneurs and workers. This policy choice creates welfare conflicts between the two groups, which is confirmed by empirical evidence. The government maximizes workers’ welfare by choosing procyclical capital income tax rates and countercyclical labor income tax rates while it optimizes entrepreneurs’ welfare with countercyclical capital income tax rates and strongly countercyclical labor income tax rates. The socially optimal policy is a tradeoff between the welfare of entrepreneurs and workers. The welfare conflict holds when the government modifies the cyclical behavior of policy in a crisis, or it adjusts the long-run level and cyclical behavior at the same time.

Use It or Lose It: Efficiency and Redistributional Effects of Wealth Taxation

AbstractHow does wealth taxation differ from capital income taxation? When the return on investment is equal across individuals, a well-known result is that the two tax systems are equivalent. Motivated by recent empirical evidence documenting persistent return heterogeneity, we revisit this question. With heterogeneity, the two tax systems typically have opposite implications for efficiency and inequality. Under capital income taxation, entrepreneurs who are more productive and therefore generate more income pay higher taxes. Under wealth taxation, entrepreneurs who have similar wealth levels pay similar taxes regardless of their productivity, which expands the tax base, shifts the tax burden toward unproductive entrepreneurs, and raises the savings rate of productive ones. This reallocation increases aggregate productivity and output. In the simulated model parameterized to match the U.S. data, replacing the capital income tax with a wealth tax in a revenue-neutral way delivers a significantly higher average welfare. Turning to optimal taxation, the optimal wealth tax (OWT) is positive and yields large welfare gains by raising efficiency and lowering inequality. In contrast, the optimal capital income tax (OKIT) is negative—a subsidy—and delivers lower welfare gains than OWT, owing to the welfare losses from higher inequality. Furthermore, when the transition path is considered, the gains from OKIT turn into significant welfare losses for existing cohorts, whereas OWT continues to deliver robust welfare gains. These results suggest that moderate wealth taxation may be a more appealing alternative than capital income taxation, which can be significantly more distorting under return heterogeneity than under the equal-returns assumption.

Simulating Tax Effects on Economic Activities in Sierra Leone: A DSGE Framework

"In order to analyse the macroeconomic effects of changes in the marginal tax rate on cyclical fluctuations in Sierra Leone, we created a DSGE model that evaluates the macroeconomic impact of three tax instruments (i.e., consumption, income, and capital). The model is calibrated with parameter values that reflect the peculiarities and representative tax structure of the Sierra Leone economy. We found that; a 5% increase in consumption tax rate causes a distortionary effect on output, consumption, and investment (in the short-run), while in the long-run output contract by 3.1%, with a permanent decline in consumption and investment. Whilst, fiscal revenues increase in the dynamic short run, 15%, higher than it previous steady-state value. On the other hand, a simulation of a 5% reduction in consumption tax, labour income tax, and capital income tax from the current rates shows a positive impact on consumption and investment as such output grows permanently by 8.45%, but fiscal revenues decrease marginally by 1.7%. The key point in the analysis is that in Sierra Leone tax changes have distortionary effects on the decisions of individuals and firms, affecting output, investment, consumption, and fiscal revenues. As such tax policy can alter economic behaviour in profound ways. We observed that fluctuations in tax rates produce large substitution effects that alter investment & consumption decisions and have distortionary effect on the behaviour of economic agents. The results suggest that the authorities should synchronize policies to manage the trade-off between the desire for more welfare gains, output growth, and the need for more fiscal revenue mobilization."

Green hydrogen for public transportation fueling and street lighting electrification: Towards more sustainable Moroccan cities

Generally, the energy consumption of public services is associated with considerable greenhouse gas emissions. Hybrid energy systems are widely deployed in several countries in an effort to reduce these emissions. However, despite their proven benefits, developing countries still lack a mainstream implementation of these systems. Therefore, this study presents an assessment of the techno-economic performance and greenhouse gas (GHG) emissions of different hybrid system configurations for hydrogen and electricity production to satisfy the needs of public transportation and street lighting in three Moroccan cities. These hybrid system configurations mainly contain PV panels, hydrogen electrolyzers and dispensers, and hydrogen and oxygen storage tanks. The main difference between the proposed configurations (i.e., C1 and C2) manifests in the exploitation routes of their produced energy (i.e., hydrogen and electricity) and by-products (i.e., oxygen and heat). The techno-economic results indicate that C2 would only be economically profitable when deployed in midsized cities (internal rate of return (IRR) higher than the discount rate (5 %)), while C1 would not be able to generate profits regardless of the cities' size (IRR < 5 %). Furthermore, the sensitivity analysis underscores the considerable dependence of the financial profitability of the designed systems on their capital costs, income taxes, and hydrogen and oxygen selling prices. Finally, findings show that C2 is able to avoid more GHG emissions compared to C1 (by 17.84 % on average).

Can Inheritance Taxation Promote Equality of Opportunities?

After a period of relatively strong economic and social mobility during the post-WWII decades, labour income is now quickly losing its capacity to fuel mobility across the wealth distribution of Western economies, with inheritance becoming again the main determinant of individuals’ ability to make it to the top of the wealth distribution. At a time where inheritance taxation therefore seems desirable from both equity and efficiency standpoints, most inheritance tax systems are broken. They have failed to be truly progressive, and have remained very unpopular among the public. In this paper, we propose general principles to guide an in-depth reform of inheritance tax systems, to make them more efficient, progressive and transparent. Using administrative survey data from France, we also discuss whether the revenue generated by these reforms can promote equality of opportunities, by guaranteeing a wealth endowment for all. Based on detailed simulations, we explain why inheritance taxation alone cannot deal with the current dynamics of concentration of wealth at the top of the distribution, and why it needs to be complemented by progressive taxation of wealth and/or capital income. <strong>JEL No:</strong> D14, D30, D31, D63, D64, H21, H24, H26, H31.

Scale‐dependent and risky returns to savings: Consequences for optimal capital taxation

AbstractI present a model of optimal capital taxation where agents with heterogeneous labor productivity randomly draw their rate of return to savings. Because of scale dependence, the distribution of rates of returns can depend on the amount saved. Uncertainty in returns to savings yields an insurance rationale for taxing capital on top of labor income. I first show that, because of scale dependence, agents making the same saving decision should access the same rate of return at the optimum. I then constrain the information set of the government and show that, as soon as return are uncertain, positive capital income taxation is needed at the optimum. The optimal linear tax on capital income trades off insurance with distortions to both savings and to the rate of return in a context of scale dependence. Eventually, I argue that scale dependence in and of itself is not sufficient to justify capital taxation on top of labor income taxes. These results are still valid when agents can optimize between a risk‐free and a risky‐asset that can both exhibit scale dependence.

Optimal Taxation of Robots

Abstract I study the optimal taxation of robots, other capital, and labor income. I show that it is optimal to distort robot adoption. The robot tax (or subsidy) exploits general-equilibrium effects to compress wages, which reduces income-tax distortions of labor supply, thereby raising welfare. In the calibrated model, when robots are expensive, a robot subsidy is optimal. As robots get cheaper, it becomes optimal to tax them. Yet, when reforming the status-quo tax system, most welfare gains can be achieved by adjusting the income tax. The additional gains from taxing robots differently from other equipment capital are close to zero.

Does idiosyncratic risk matter for climate policy?

AbstractThis paper studies the implications of distortions in intertemporal margins for the conduct of climate policy. We do so by introducing a framework that combines a standard two-period overlapping generations (OLG) model with a tractable model of household heterogeneity, in which over-accumulation of capital arises from uninsurable idiosyncratic labor income risk. We illustrate that market-based climate policies must be adjusted when the government cannot provide full insurance to households by taxing only capital and is constrained to transfer resources across generations for risk-sharing. In a numerical exercise, we find that idiosyncratic risk leads to an optimal capital income tax rate of 35 per cent and a carbon price 7.5 per cent lower than its first best.

Technological progress and optimal income taxation

Facing technological progress, how should a government reform income taxation? To address this question, optimal capital and labor income taxation is obtained for an economy of heterogeneous individuals. Technological progress raises optimal capital income tax rate and lowers optimal average marginal labor income tax rate if it is capital-biased by increasing relative capital productivity. Technological progress does the opposite if it is labor-biased by decreasing relative capital productivity. Neither capital-biased nor labor-biased technological progress affects optimal slope of labor income tax rate schedule. Technological progress does not affect optimal income taxation if it is unbiased by preserving relative capital productivity.

Explaining the decline in the US labor share: taxation and automation

This study provides evidence for the USA that the secular decline in the labor share is not only explained by technical change or globalization, but also by the dynamics of factor taxation, automation capital (robots), and population growth. First, we empirically find indications of co-integration for the period from the last quarter of the 20th to the first decade of the twenty-first century. Permanent effects on factor shares emanate from relative factor taxation. The latter also have a lasting effect on the use of robots. Variance decompositions reveal that taxing contributes to changes in the two income shares and in automation capital. Second, we analyze and calibrate a neoclassical growth model extended to include factor taxation, automation capital, and capital adjustment costs. Labor and automation capital are perfect substitutes, whereas labor and traditional capital are complements. The model replicates the dynamics of the observed functional income distribution in the USA during the 1965–2015 period. Counterfactual experiments suggest that the fall in the labor share would have been significantly smaller if labor and capital income tax rates had remained at their respective level of the 1960s.

Overreaction to capital taxation in saving decisions

This paper studies the response of saving decisions to two alternative types of capital taxation: the wealth tax and the capital income tax. First, we conducted a lifecycle experiment using Amazon MTurk, wherein subjects made dynamic saving decisions. Subjects exhibited an overreaction to wealth taxes but not to capital income taxes: subjects’ savings decreased more with the introduction of a wealth tax than with a financially equivalent drop in capital returns. Second, we built a parsimonious behavioral model of individual optimization to characterize this overreaction and illustrate its welfare implications. Finally, additional treatments began to explore the root cause of this overreaction bias. We ruled out the explanation that the intrinsic aversion to paying wealth taxes drives overreaction. Instead, overreaction seems to be driven by subjects’ incorrect understanding of the effects of wealth taxes on their savings.

Housing property tax, economic growth, and intergenerational welfare: The case of China

In an endogenous growth model of overlapping generations, this paper shows that an introduction of a housing property tax in China increases physical and human capital accumulation and growth rate of output in the long run no matter the revenue from housing property tax is used for reducing government debt, personal income tax, or capital income tax, or for increasing government education expenditure. The tax reform has a strong inter-generations redistribution effect, i.e., it increases the welfare of future generations but reduces the welfare of current generations.

Using the primal approach to derive the second‐best rules for different public services in a general competitive growth model

Using the <i>primal</i> approach to derive the second‐best rules for different public services in a general competitive growth model

Understanding international differences in the skill premium: The role of capital taxes and transfers

We show that the size of the tax and transfer system affects the level of wage inequality in a heterogeneous agent/incomplete markets model, extended to allow for capital–skill complementarity. The skill premium can decrease significantly with an increase in the size of the tax and transfer system due to a rise in the capital income tax rate when idiosyncratic shocks to labor productivity are not insurable. The differences in the steady-state skill premium under different capital income tax rates are consistent with those observed across countries.

Italy’s demographic trap: Voting for childcare subsidies and fertility outcomes

In this paper we study how population aging impacts the age distribution of the voting electorate and voters’ choices over childcare subsidies. We build a computable general equilibrium framework populated by heterogeneous agents who, over the course of their life-cycle, make endogenous and age-dependent fertility choices. The model is calibrated to match economic and population outcomes of the Italian economy. Child support favors young and fertile cohorts but can also impact all population subgroups through changes in prices, income taxation and population growth. A probabilistic voting model is used to measure voting outcomes over a range of childcare subsidy levels and tax policies. Our findings show that childcare subsidies have a positive impact on the total fertility rate and are welfare improving when financed with both capital and labor income taxation and in combination with lower pension contribution rates. A 10 percent increase in the level of subsidies can increase the population growth rate by an average of 0.47–0.70 percentage points. We find that voting choices of different population subgroups, while depending on the tax used to finance new expenditure, lead to lower levels of childcare subsidies, lower fertility rates and to a demographic ‘trap’.

Revisiting Uzawa–Lucas with public human capital spending and productivity heterogeneity

PurposeThis paper aims to study the effects of public human capital spending on growth under the presence of financial frictions and productivity heterogeneity. In addition, this paper derives and discusses growth-maximizing policy.Design/methodology/approachThis paper constructs a tractable human capital–based growth model. There a continuum of heterogeneous entrepreneurs who own private firms, accumulate personal wealth and face collateral borrowing constraints. The representative worker accumulates human capital by using his own efforts, the existing human capital stock and human capital–related public services. The government finances public spending by taxing capital income. This paper then focuses its analysis on the balanced growth path equilibrium of the economy model.FindingsThis paper finds that public human capital spending financed by capital income taxation yields strictly higher growth than when the spending is absent. In addition, it shows that the growth-maximizing capital income tax rate is higher when the idiosyncratic firm productivity distribution is more heavy tailed.Originality/valueThis paper embraces and then explores the effects of productivity heterogeneity and financial frictions into an otherwise conventional human capital–based endogenous growth model. This paper also differs from the conventional endogenous growth framework by incorporating the productive role of public services in the process of accumulating human capital. Therefore, it can address the effects of public spending on growth.

Capital depreciation allowances, redistributive taxation, and economic growth

AbstractAre capital depreciation allowances when coupled with capital income taxes good instruments for redistribution in the long run? In a simple two‐agent‐economy I find that accelerated depreciation is good for growth, but bad for redistribution. The opposite holds for capital income taxes. However, in a feedback Stackelberg equilibrium, where the government is the leader and the private sector the follower, the depreciation allowance is maximal in the long run, time‐consistent optimum. This removes the accumulation distortion of capital income taxes. Furthermore, the latter, and so redistribution, is found to be generically nonzero in the time‐consistent optimum, and depends on the social weight of transfers receivers, the pretax factor income distribution, the intertemporal elasticity of substitution and the time preference rate. Thus, accelerated depreciation allowances are an important indirect tool for redistribution. The tax scheme allows for a separation of “efficiency” and “equity” concerns for redistributive policies.

Incentive effect of structural tax reduction policy on consumption upgrading and high-tech industry

China is implementing a structural tax reduction policy to upgrade the structure of household consumption and promote the development of high-tech industry. This article constructs a heterogeneous NK-DSGE (New Keynesian - Dynamic Stochastic General Equilibrium) model to study the effects of tax reduction policies on consumption upgrading and the development of high-tech industry. The tax categories involved in this model are divided into demand-side tax and supply-side tax. We build two indexes to measure the consumption structure and the development of high-tech industry. It is found that reducing high-tech enterprise income tax would upgrade the consumption structure and promote the development of high-tech industries in the short term. Reducing low-tech enterprise income tax would achieve similar effects in the medium and long term. Moreover, tax such as consumption tax, labour income tax and capital income tax reduction policies can upgrade the consumption structure and promote the development of high-tech industry in the long term. Finally, this article finds that when the elasticity of labour substitution is smaller, reducing high-tech enterprise income tax is more effective.

Optimal Fiscal Policy in a Model with Uninsurable Idiosyncratic Income Risk

AbstractWe study optimal fiscal policy in a standard incomplete-markets model with uninsurable idiosyncratic income risk, where a Ramsey planner chooses time-varying paths of proportional capital and labour income taxes, lump-sum transfers (or taxes), and government debt. We find that (1) short-run capital income taxes are effective in providing redistribution since the tax base is relatively unequal and inelastic; (2) an increasing pattern of labour income taxes over time mitigates intertemporal distortions from capital income taxes; (3) the optimal policy increases overall transfers, calibrated initially to the US welfare system, by roughly $50\%$; (4) two-thirds of the welfare gains come from redistribution and the remaining third come mostly from insurance; and (5) redistribution also leads to a more efficient allocation of labour via wealth effects on labour supply—lower productivity households can afford to work relatively less.