Externality Cost of Capital Investment in Limited Commitment

KDI Journal of Economic Policy 2012, 34(2) 17-40

25 Pages Posted: 4 May 2016

See all articles by YiLi Chien

YiLi Chien

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Junsang Lee

Korea Development Institute (KDI)

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

Chien, YiLi and Lee, Junsang, Externality Cost of Capital Investment in Limited Commitment (June 30, 2012). KDI Journal of Economic Policy 2012, 34(2) 17-40, Available at SSRN: https://ssrn.com/abstract=2774005

YiLi Chien (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Junsang Lee

Korea Development Institute (KDI) ( email )

263 Namsejong-ro
Sejong-si 30149
Korea, Republic of (South Korea)

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