Optimal Capital Versus Labor Taxation with Innovation-Led Growth

45 Pages Posted: 31 May 2013 Last revised: 6 Aug 2014

See all articles by Philippe Aghion

Philippe Aghion

College de France and London School of Economics and Political Science, Fellow; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Ufuk Akcigit

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER); Center for Economic and Policy Research (CEPR)

Jesús Fernández-Villaverde

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2013

Abstract

Chamley (1986) and Judd (1985) showed that, in a standard neoclassical growth model with capital accumulation and infinitely lived agents, either taxing or subsidizing capital cannot be optimal in the steady state. In this paper, we introduce innovation-led growth into the Chamley-Judd framework, using a Schumpeterian growth model where productivity-enhancing innovations result from profit-motivated R&D investment. Our main result is that, for a given required trend of public expenditure, a zero tax/subsidy on capital becomes suboptimal. In particular, the higher the level of public expenditure and the income elasticity of labor supply, the less should capital income be subsidized and the more it should be taxed. Not taxing capital implies that labor must be taxed at a higher rate. This in turn has a detrimental effect on labor supply and therefore on the market size for innovation. At the same time, for a given labor supply, taxing capital also reduces innovation incentives, so that for low levels of public expenditure and/or labor supply elasticity it becomes optimal to subsidize capital income.

Suggested Citation

Aghion, Philippe and Akcigit, Ufuk and Fernández-Villaverde, Jesús, Optimal Capital Versus Labor Taxation with Innovation-Led Growth (May 2013). NBER Working Paper No. w19086. Available at SSRN: https://ssrn.com/abstract=2272522

Philippe Aghion (Contact Author)

College de France and London School of Economics and Political Science, Fellow ( email )

London
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ufuk Akcigit

University of Chicago - Department of Economics ( email )

1126 E. 59th St
Chicago, IL 60637
United States

HOME PAGE: http://www.ufukakcigit.com

National Bureau of Economic Research (NBER) ( email )

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Center for Economic and Policy Research (CEPR) ( email )

London
United Kingdom

Jesús Fernández-Villaverde

University of Pennsylvania - Department of Economics ( email )

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Philadelphia, PA 19104
United States
215-898-1504 (Phone)
215-573-2057 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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