On the Optimal Timing of Taxes
43 Pages Posted: 31 Jan 2005
Date Written: November 2004
Abstract
This Paper analyzes the optimal timing of taxes on capital income. We show that the celebrated result that taxes should be front-loaded with an initially high tax followed by a discrete jump to the steady state is knife-edge, hinging on capital having a constant depreciation rate. An empirically supported deviation from this case, involving depreciation rates that increase over the lifespan of the investment, implies that optimal taxes should oscillate. Furthermore, the optimality of fluctuating tax rates hinges on the government being able to commit to the path of future tax rates. Without commitment, optimal taxes may be smooth also under accelerating depreciation. In a calibrated example, we find that optimal taxes are oscillating under commitment and smooth without commitment.
Keywords: Optimal taxation, tax dynamics, time-consistency, capital depreciation
JEL Classification: D90, E61, H21, H30
Suggested Citation: Suggested Citation
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