Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives (original) (raw)
This paper analyzes the optimal tax on capital income in general equilibrium models of the second best. Agents have infinite lives and utility functions which are extensions from the Koopmans form. The population is heterogeneous. The important property of the models is the equality between the social and the private discount rates in the long run. I find that the optimal tax rate is zero in the long run. For a special case of additively separable utility functions, I then determine the tax rates along the dynamic path and conditions that are sufficient for the local stability of the steady state. ' Discussions with Paul Champsaur, Dale Jorgenson, Laurence Kotlikoff, and participants of seminars at C.O.R.E. and at Yale have been stimulating. Comments by the editor and by an anonymous referee were particularly helpful. Partial financial support from a C.O.R.E. fellowship is gratefully acknowledged. Donna Zerwitz provided expert editorial assistance. * Pestieau [13] has shown that under some conditions, the standard Ramsey tax formulae (Diamond and Mirrlees [a]), apply in the steady state of a general equilibrium model with overlapping generations. For a discussion of some of these conditions, see Atkinson and Sandmo [3]. Summers [14] has remarked that in life-cycle models with additively separable utility functions and constant pure rate of time preference, the long-run interest elasticity of supply for savings increases with the number of periods. This would imply that the interest tax has a large welfare cost, and that its rate in the second best is relatively low. His analysis is restricted to a comparison between steady states. The framework of this paper does not make these restrictive assumptions about the utility function, and the second best policy optimizes over the entire dynamic path.
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