Taxing Capital? Not a Bad Idea after All!

29 Pages Posted: 31 Jan 2007 Last revised: 12 Sep 2010

See all articles by Juan C. Conesa

Juan C. Conesa

Universitat Pompeu Fabra

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)

Date Written: January 2007

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 in our model the optimal capital income tax rate 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.

Suggested Citation

Conesa, Juan C. and Kitao, Sagiri and Krueger, Dirk, Taxing Capital? Not a Bad Idea after All! (January 2007). NBER Working Paper No. w12880. Available at SSRN: https://ssrn.com/abstract=960454

Juan C. Conesa

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
08005 Barcelona
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 (Contact Author)

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/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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