Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing

27 Pages Posted: 22 May 2017

See all articles by Nina Biljanovska

Nina Biljanovska

International Monetary Fund (IMF)

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System

Date Written: 2017-05-05

Abstract

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

Suggested Citation

Biljanovska, Nina and Vardoulakis, Alexandros, Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing (2017-05-05). FEDS Working Paper No. 2017-053, Available at SSRN: https://ssrn.com/abstract=2971392 or http://dx.doi.org/10.17016/FEDS.2017.053

Nina Biljanovska (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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