Human Capital External Effect and Taxation of Physical Capital Income
13 Pages Posted: 28 Feb 2006
Date Written: February 13, 2006
It is commonly believed that taxation of physical capital is "a bad idea". Whereas in reality many countries do levy heavy taxes on capital income. In this paper we show that taxation of physical capital can be justified when there is non-convexity of technology due to human capital external effect. We demonstrate that taxation of capital income should be implemented via residence-based taxation, that is, to increase the welfare of the residents of the country, the government has to levy the entire tax burden only on them. We also show that source-based taxation reduces welfare.
Keywords: human capital, capital income taxation, education subsidies
JEL Classification: H2, H5, I2, J2
Suggested Citation: Suggested Citation