Taxing Capital? Not a Bad Idea after All!

31 Pages Posted: 29 Dec 2006

See all articles by Juan Carlos Conesa

Juan Carlos Conesa

University of Barcelona

Sagiri Kitao

City University of New York, CUNY Hunter College - Department of Economics

Dirk Krueger

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 2006

Abstract

In this paper we quantitatively characterize the optimal capital and labor income tax in an overlapping generations model with idiosyncratic, uninsurable income shocks, where households also differ permanently with respect to their ability to generate income. The welfare criterion we employ is ex-ante (before ability is realized) expected (with respect to uninsurable productivity shocks) utility of a newborn in a stationary equilibrium. Embedded in this welfare criterion is a concern of the policy maker for insurance against idiosyncratic shocks and redistribution among agents of different abilities. Such insurance and redistribution can be achieved by progressive labor income taxes or taxation of capital income, or both. The policy maker has then to trade off these concerns against the standard distortions these taxes generate for the labor supply and capital accumulation decision. We find that the optimal capital income tax rate is not only positive, but is significantly positive. The optimal (marginal and average) tax rate on capital is 36%, in conjunction with a progressive labor income tax code that is, to a first approximation, a flat tax of 23% with a deduction that corresponds to about $6,000 (relative to an average income of households in the model of $35,000). We argue that the high optimal capital income tax is mainly driven by the life cycle structure of the model whereas the optimal progressivity of the labor income tax is due to the insurance and redistribution role of the income tax system.

Keywords: Progressive taxation, capital taxation, optimal taxation

JEL Classification: E62, H21, H24

Suggested Citation

Conesa, Juan Carlos and Kitao, Sagiri and Krueger, Dirk, Taxing Capital? Not a Bad Idea after All! (November 2006). CEPR Discussion Paper No. 5929, Available at SSRN: https://ssrn.com/abstract=954168

Juan Carlos Conesa (Contact Author)

University of Barcelona ( email )

Gran Via de les Corts Catalanes, 585
Barcelona, 08007
Spain

Sagiri Kitao

City University of New York, CUNY Hunter College - Department of Economics ( email )

695 Park Avenue
New York, NY 10021
United States

Dirk Krueger

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6691 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~dkrueger/

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Centre for Economic Policy Research (CEPR)

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