Why Governments Should Tax Mobile Capital in the Presence of Unemployment

University of Munich, Center for Economic Studies Working Paper No. 175

Posted: 12 Mar 1999

See all articles by Erkki Koskela

Erkki Koskela

University of Helsinki - Department of Political and Economic Studies; CESifo (Center for Economic Studies and Ifo Institute); Bank of Finland - Research Department; IZA Institute of Labor Economics

Ronnie Schöb

Freie Universitaet Berlin; CESifo (Center for Economic Studies and Ifo Institute)

Abstract

This paper shows that a small open economy should levy positive source-based taxes on capital income to fight involuntary unemployment and increase welfare. A revenue-neutral tax reform which increases the capital tax rate and reduces the labour tax rate will induce firms to substitute labour for capital. Such a tax will lower marginal cost of production, increase output, and reduce unemployment as long as labour tax rate exceeds the capital tax rate. The result holds even though trade unions might succeed in subsequently increasing the net-of-tax wage rate if the elasticity of substitution between capital and labour is above a critical value which is itself below one. Independent of the elasticity of substitution, the government can promote wage moderation by increasing the personal tax credit instead of reducing the labour tax rate.

JEL Classification: H2, J5

Suggested Citation

Koskela, Erkki and Schöb, Ronnie, Why Governments Should Tax Mobile Capital in the Presence of Unemployment. University of Munich, Center for Economic Studies Working Paper No. 175. Available at SSRN: https://ssrn.com/abstract=148476

Erkki Koskela

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland
+358 9 191 8894 (Phone)
+358 9 191 8877 (Fax)

HOME PAGE: http://www.cesifo.de/servlet/page?_pageid=56&_dad=portal30&_schema=PORTAL30&pa_id=7298

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Bank of Finland - Research Department ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Ronnie Schöb (Contact Author)

Freie Universitaet Berlin ( email )

Boltzmannstraße 20
Berlin, Berlin 14195
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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