On the Optimal Taxation of Capital Income

38 Pages Posted: 17 Oct 2007 Last revised: 15 May 2022

See all articles by Larry Jones

Larry Jones

University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

Rodolfo Manuelli

University of Wisconsin - Madison - Center for Community Economic Development

Peter E. Rossi

University of California, Los Angeles (UCLA) - Anderson School of Management

Date Written: November 1993

Abstract

One of the best known results in modern public finance is the Chamley-Judd result showing that the optimal tax rate on capital income is zero in the long-run. In this paper, we reexamine this result by analyzing a series of generalizations of the Chamley-Judd formulation. We show that in a model with human capital, if the tax code is sufficiently rich and there are no pure profits from accumulating human capital, then all distorting taxes are zero in the long-run under the optimal plan. In this sense, income from physical capital is not special. To gain a better understanding of these two conditions, we study examples in which they are not satisfied and show that the optimal tax rate on income from physical capital does not go to zero. In those cases where the limiting tax rate is non-zero, we calculate its value for alternative specifications of the marginal welfare cost of taxation. Our results indicate that even for conservative specifications, tax rates of 10% and higher are possible under the optimal code.

Suggested Citation

Jones, Larry E. and Manuelli, Rodolfo and Rossi, Peter E., On the Optimal Taxation of Capital Income (November 1993). NBER Working Paper No. w4525, Available at SSRN: https://ssrn.com/abstract=480269

Larry E. Jones (Contact Author)

University of Minnesota - Twin Cities - Department of Economics ( email )

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Minneapolis, MN 55455
United States

National Bureau of Economic Research (NBER)

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Rodolfo Manuelli

University of Wisconsin - Madison - Center for Community Economic Development

Madison, WI
United States

Peter E. Rossi

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States
773-294-8616 (Phone)