Why is the Long-Run Tax on Capital Income Zero? Explaining the Chamley-Judd Result

Tinbergen Discussion Paper 2017-011/VI

30 Pages Posted: 24 Jan 2017

See all articles by Bas Jacobs

Bas Jacobs

Erasmus University Rotterdam (EUR); Tinbergen Institute; CESifo (Center for Economic Studies and Ifo Institute)

Alexandra Rusu

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Date Written: January 12, 2017

Abstract

Why is it optimal not to tax capital income in the long-run in Chamley (1986) and Judd (1985)? This paper demonstrates that the answer follows standard intuitions from the commodity tax literature. In the steady state, Engel curves for consumption are linear in labour earnings, irrespective of the utility function adopted. Thus, in the steady state, consumption demands in each period become equally complementary to leisure over time. This renders taxes on capital income redundant, since they cannot alleviate distortions from taxing labour income. The argument that taxes on capital income should be zero because distortions explode in finite time is relevant only if restrictions are imposed on the utility function. We show how these restrictions imply that consumption demands in each period are equally complementary to leisure over time. We also demonstrate that the optimal tax on capital income is zero irrespective of whether the gross interest rate is endogenous. This contradicts arguments that the entire burden of capital income taxes is shifted to labour through general equilibrium effects on the interest rate.

Keywords: taxation of capital income, zero capital income tax, Corlett-Hague motive, Chamley-Judd result

JEL Classification: H2

Suggested Citation

Jacobs, Bas and Rusu, Alexandra, Why is the Long-Run Tax on Capital Income Zero? Explaining the Chamley-Judd Result (January 12, 2017). Tinbergen Discussion Paper 2017-011/VI. Available at SSRN: https://ssrn.com/abstract=2903830 or http://dx.doi.org/10.2139/ssrn.2903830

Bas Jacobs (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

PO Box 1738
Rotterdam, Zuid-Holland 3000 DR
Netherlands
+314081452 (Phone)

HOME PAGE: http://people.few.eur.nl/bjacobs

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Alexandra Rusu

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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