Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing
27 Pages Posted: 22 May 2017
Date Written: 2017-05-05
We study optimal long-run capital taxation in a closed economy with heterogeneity in agents' time-discount factors where borrowing is allowed but restricted by a collateral constraint. Financial frictions distort intertemporal optimization margins and the tax system serves a dual role: first, it is used to finance government consumption; second, it serves to alleviate the distortions arising from the binding collateral constraint. The discrepancy between the private and the social discount factors pushes for a subsidy on capital, while the discrepancy introduced by the collateral constraint pushes for a tax in the long-run. When consumption smoothing motives are muted, the two effects counter-balance each other and the tax is zero. With finite elasticity of intertemporal substitution, the second discrepancy dominates and the tax on capital income is positive in the long-run.
Keywords: Ramsey taxation, Collateral constraint, Heterogeneous discount factors, Tax on capital
JEL Classification: E60, E61, E62, H21
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