Optimal Taxation with Current and Future Cohorts

20 Pages Posted: 1 Nov 2012

See all articles by Hans Fehr

Hans Fehr

University of Würzburg - Institute of Economics and Social Sciences

Fabian Kindermann

University of Regensburg; Netspar

Date Written: October 30, 2012

Abstract

This note demonstrates that optimal tax calculations in overlapping generations models should not be based exclusively on long-run welfare changes. As the latter represent a mix of efficiency and intergenerational redistribution effects, they typically favor policies which redistribute towards future cohorts. Taking the recent study of Conesa et al. (2009) as an example, we explicitly consider short- and long-run welfare effects and isolate the aggregate efficiency consequences of a tax reform. Based on this aggregate efficiency measure, we find a much lower capital income tax rate and a significantly less progressive labor income tax schedule than Conesa et al. (2009) to be optimal. As we demonstrate, the optimality of capital income taxation is explained by the low interest elasticity of precautionary savings compared to that of life-cycle savings.

Keywords: stochastic OLG model, precautionary savings, intragenerational risk sharing and redistribution

JEL Classification: C680, H210, D910

Suggested Citation

Fehr, Hans and Kindermann, Fabian, Optimal Taxation with Current and Future Cohorts (October 30, 2012). CESifo Working Paper Series No. 3973, Available at SSRN: https://ssrn.com/abstract=2168701 or http://dx.doi.org/10.2139/ssrn.2168701

Hans Fehr (Contact Author)

University of Würzburg - Institute of Economics and Social Sciences ( email )

Sanderring 2
D-97070 Wuerzburg
Germany
0931- 31 29 72 (Phone)
0931- 888 71 29 (Fax)

Fabian Kindermann

University of Regensburg ( email )

Universitaetsstrasse 31
D-93040 Regensburg
Germany

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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