Externality Cost of Capital Investment in Limited Commitment
KDI Journal of Economic Policy 2012, 34(2) 17-40
25 Pages Posted: 4 May 2016
Date Written: June 30, 2012
Abstract
We study externality costs of capital investment under limited commitment. We solve for the constrained efficient allocation with a limited commitment environment and find positive externality costs of capital investment provided that full-risk-sharing is not feasible. In a decentralized version of limited commitment environment, a one unit increase of capital investment by an agent increases all individuals’ autarky values in the economy and generates externality costs in the economy. This externality cost provides a rationale for positive capital taxation even in the absence of government expenditure. In order to internalize this costs, the government use a positive rate of linear capital tax in the decentralized economy.
Keywords: Capital Investment, Capital Taxation, Limited Commitment
JEL Classification: D62, E22, H21
Suggested Citation: Suggested Citation