Optimal Capital Tax Rate Research Articles

The Ramsey steady-state conundrum in heterogeneous-agent economies

This paper makes two fundamental contributions: (i) We prove that the interior Ramsey steady state commonly assumed in the literature may not exist in a standard Aiyagari model—in particular, a steady state with the modified golden rule and a positive capital tax is shown to be feasible but not optimal under conventional parameter values for the intertemporal elasticity of substitution. (ii) We design a modified, analytically tractable version of the standard Aiyagari model to reveal the necessary and/or sufficient conditions for the existence of a Ramsey steady state. We characterize the basic properties of both interior and non-interior Ramsey steady states and show that researchers may draw fundamentally misleading conclusions about optimal fiscal policy (such as the optimal capital tax rate) from their analysis if an interior Ramsey steady state is incorrectly assumed.

Optimal capital taxation in an economy with innovation-driven growth

AbstractThis paper investigates optimal capital taxation in an innovation-driven growth model. We examine how the optimal capital tax rate varies with externalities associated with R&D and innovation. Our results show that the optimal capital tax rate is higher when (i) the “stepping on toes effect” is smaller, (ii) the “standing on shoulders effect” is stronger, or (iii) the extent of creative destruction is smaller. The optimal capital tax rate is more likely to be positive when there is underinvestment in R&D. Moreover, the optimal capital tax rate and the monopolistic markup exhibit an inverted-U relationship. By calibrating our model to the US economy, we find that the optimal capital tax rate is positive, at a rate of around 6.6%. Finally, we consider a number of extensions and find that the result of a positive optimal capital tax is robust.

Dynamic Pre-distributive Capital Tax Design with Raising Skill Premium

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.

Overreaction to Capital Taxation in Saving Decisions

We study the response of saving decisions to two alternative capital taxation, i.e., wealth tax and capital income tax. We conduct an online “life-cycle” experiment on Amazon Mturk, where subjects make dynamic saving decisions. Subjects exhibit an overreaction to the wealth tax, not to the capital income tax: the subject saves significantly less with the introduction of wealth tax than with a financially equivalent drop in capital return. Furthermore, we build a parsimonious behavioral model of individual optimization to characterize the overreaction. Finally, to quantitatively illustrate the policy implication of overreaction for optimal capital taxation analysis, we use the same model and calibration as the seminal study of Conesa et al. (2009), but modified it to allow for behavioral overreaction. The results show that a larger overreaction bias generates more welfare loss for the economy. The optimal capital tax rate decreases as households overreact more to capital taxation.

Taxing Capital in the Presence of Trickle Down Effects: A Sufficient Statistics Approach

Within a rich dynamic environment I derive a robust and testable condition for the optimality of capital income tax rates. I apply this condition to US data. Endogenous responses of factor prices mitigate welfare gains of capital tax increases for a large fraction of the population, who derives most of its disposable income from net wages. However, due to a positive revenue impact, the same price responses amplify the welfare gains of the very bottom of the income distribution, whose main income source are government transfers. As a consequence, general equilibrium forces may increase the optimal capital tax rate relative to its exogenous price counterpart, contradicting conventional wisdom.

Optimal Ramsey Capital Taxation with Endogenous Government Spending

The authors study optimal capital income taxation in heterogeneous agent economies featuring endogenous government spending. Similar to Aiyagari (1995), they find that the long-run optimal capital tax rate should not be zero as long as the competitive equilibrium risk-free interest rate differs from the subjective time discount rate. The authors first argue that this result holds in a wide range of economic environments and is not limited to only the standard incomplete market model with heterogeneous agents. As an example, a decentralized economy with limited commitment is considered. Second, they show that this result critically depends on the assumption of endogenous government spending. Within the same limited commitment environment, they show that the long-run capital taxation becomes zero with exogenous government spending. The authors conclude that the optimal Ramsey taxation in heterogeneous agent economies with exogenous government spending and various frictions is still an open question.

OPTIMAL TAXATION AND SOCIAL NETWORKS

We study optimal taxation when jobs are found through a social network. The network determines employment, which workers may influence by engaging in social activities. The network parameters play an important role in determining the economy's employment level and the optimal income tax. The optimal labor income tax depends on both the traditional intensive margin of labor supply and a new extensive margin that depends on the structure of the social network. Social activities that promote social connections are instrumental to acquiring job information; taxation thus discourages both social activities and labor supply, reducing employment. Labor taxes vary positively with labor supply and negatively with employment. When networking is absent, taxes are higher and the economy's employment rate is lower. The optimal capital tax rate is zero, independent of labor market frictions. Social networking reduces job search frictions and is welfare-enhancing.

Dynamic Tax Competition under Asymmetric Productivity of Public Capital

We here expand the static tax competition models in symmetric small regions, which were indicated by Zodrow and Mieszkowski (1986) and Wilson (1986), to a dynamic tax competition model in large regions, taking consideration of the regional asymmetry of productivity of public capital and the existence of capital accumulation. The aim of this paper is to verify how the taxation policy affects asymmetric equilibrium based on a simulation analysis using an overlapping generations model in two regions. It is assumed that the public capital as a public input is formed on the basis of the capital tax of local governments and the lump-sum tax of the central government. As demonstrated in related literature, the optimal capital tax rate should become zero when the lump-sum tax is imposed only on older generations, however, the optimal tax rate may become positive when it is imposed proportionally on younger and older generations. In the asymmetric equilibrium, several cooperative solutions can possibly exist which can achieve a higher welfare standard than the actualized cooperative solution either in Region1 or 2.

A Note on the Dynamic Analysis of Fiscal Competition

This note presents an analysis of dynamic aspects of fiscal competition in a model with local capital accumulation. This shows that, even when a head tax is available, the optimal capital tax rate is generally non-zero. In addition, a decentralised equilibrium without a head tax might be characterised by overprovision of local public goods in a dynamic fiscal competition model. The source of inefficiency is overaccumulation of local capital.

A note on unemployment and capital tax competition

We introduce a labor market imperfection into the capital tax competition literature to study the equilibrium tax formulae and their efficiency in the presence of unemployment. Since we allow for labor market imperfection, the standard conclusions of the tax competition literature would be generalized in the case of non-full employment. Our first result shows that even when head taxes on immobile residents are available, the optimal capital tax rate for jurisdictional governments is not zero. Our second finding is that decentralized equilibrium might be characterized by the overprovision of local public goods when the labor market is imperfect.

Tax Competition and Asymmetric Countries

This paper explores the consequences of a difference in the levels of public inputs accumulated over time in a small open economy model where capital tax revenues are used exclusively for the provision of public inputs, while the government sets the capital tax rate in way to maximise its country’s national income. It is shown that in this case the optimal capital tax rate in a country is a decreasing function of its stock of accumulated public inputs. The model thus implies that capital tax harmonisation could actually be detrimental to the so-called core EU member states as it could fix their capital tax rates at an in-optimally high levels and thus hinder their ability to dampen undesirable capital out- flows.

The Capital Tax and Welfare Effects from Asymmetric Information on Equity Markets

This paper explores the implications of informational asymmetries between domestic and foreign investors for optimal capital tax rates and welfare. It adopts a model in which asymmetric information implies a home bias in equity. The paper finds that asymmetric information may raise capital tax rates by reducing the marginal cost of taxation. Furthermore, it shows that investors may gain from informational asymmetries. Although asymmetric information increases the uncertainty as perceived by investors, it may also increase tax rates and allow for a higher consumption of public goods. This reflects that asymmetric information may reduce the distortionary effects of competition among governments.

Imperfect Capital Mobility and Local Government Behaviour in a Two‐Period Economy

One clear result in the tax competition literature is that, when head taxes on immobile residents are available, the optimal capital tax rate for local government is zero. However, zero tax rate, when resident taxes are available, is incompatible with the phenomenon actually observed. In most countries, local governments use capital taxes as policy variables for choosing a nonzero tax rate. This paper presents a model of a two‐period economy with imperfect mobile capital to explain the behaviour of local government providing capital subsidies on capital. It further examines an equilibrium tax rate where local government’s objectives include Niskanen‐type revenue‐maximizing.

International Capital Competition and Environmental Standards

This paper examines the welfare effects of capital taxation and environmental standards with and without a government spending constraint or international tax credits. This analysis delineates the intricate linkages of the two policy measures to both private income and government welfare. Loosening environmental control leads to more capital tax revenue for the government. The optimal capital tax rate may be of any sign, depending upon the ranking of the weights of government objectives and private utility. The same criterion also applies in determining how stringent the optimal environmental standards should be.

International Capital Competition and Environmental Standards

This paper examines the welfare effects of capital taxation and environmental standards with and without a government spending constraint or international tax credits. This analysis delineates the intricate linkages of the two policy measures to both private income and government welfare. Loosening environmental control leads to more capital tax revenue for the government. The optimal capital tax rate may be of any sign, depending upon the ranking of the weights of government objectives and private utility. The same criterion also applies in determining how stringent the optimal environmental standards should be. Over the last decade, increasingly strong advocacy for environmental preservation in the U.S. has led to the passage of environmental regulations and laws that have resulted in the relocation of many U.S. firms and plants to other less environmentally conscious countries. Similarly, the tougher environmental regulations recently adopted by the newly industrialized economies, for example, the Asian Four Little Dragons-Korea, Taiwan, Hong Kong, and Singapore-have also resulted in the relocation of their polluting industries into neighboring mainland China and several Southeast Asian nations. Raising environmental standards apparently can have the effect of triggering outflows of capital and the loss of domestic jobs. Another major factor affecting international capital movement is the tax-rate differential on capital. For example, Hong Kong has perhaps the lowest corporate tax rate in the world, and the city-state has attracted foreign capital inflows from all over the world. A ceteris paribus increase in the capital tax rate means a diminishing competitive edge for keeping capital at home and, subsequently, capital outflow. Capital outflows can result in a fall in capital-tax revenue for the home country. If the country relies on revenue from capital tax to finance public expenditures, the fall in capital-tax revenue would jeopardize the provision of public services and the implementation of worthy noneconomic activities. Apparently, intricate links exist among environmental standards, capital tax rates, private income, and social welfare. Recently, there has been an upsurge of academic interest in the