Optimal Capital Taxation for Time-Nonseparable Preferences

34 Pages Posted: 19 Mar 2013

See all articles by Sebastian Koehne

Sebastian Koehne

Stockholm University - Institute for International Economic Studies (IIES)

Moritz Kuhn

University of Bonn

Date Written: March 18, 2013

Abstract

This paper studies the effect of habit formation on optimal capital taxes in a dynamic Mirrleesian model. We make three distinct contributions. First, we decompose intertemporal wedges (implicit capital taxes) for general time-nonseparable preferences into a wealth effect, a complementarity effect, and a future incentive effect. Second, we provide conditions under which intertemporal wedges are positive. Third, we derive a recursive formulation of constrained efficient allocations and evaluate the quantitative impact of habit formation. In a model parameterized to the U.S. economy, habit formation reduces average intertemporal wedges by about 40 percent compared to the time-separable case. Moreover, intertemporal wedges are close to zero for the largest part of the working life.

Keywords: optimal taxation, intertemporal wedge, habit formation, recursive contracts, new dynamic public finance

JEL Classification: D82, E21, H21

Suggested Citation

Koehne, Sebastian and Kuhn, Moritz, Optimal Capital Taxation for Time-Nonseparable Preferences (March 18, 2013). Available at SSRN: https://ssrn.com/abstract=2235171 or http://dx.doi.org/10.2139/ssrn.2235171

Sebastian Koehne (Contact Author)

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm University
Stockholm, SE-10691
Sweden

Moritz Kuhn

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany