Working Paper: CEPR ID: DP16226
Authors: Pietro Reichlin
Abstract: I study the optimal redistributive tax structure on capital and labor in a version of the Judd (1985)’s model supplemented by skill biased technology and perfect correlation between skills and wealth. Assuming that the planner is forced to implement a log-linear (progressive) tax and transfer function of pre-tax labor income (often used in public finance), and that low skilled households are hand to mouth consumers, I show that the optimal long-run capital tax rate is positive and the labor marginal tax rate can be positive or negative, depending on demand elasticities as well as on the impact of capital on the skill premium. A positive capital tax serves the purpose of reducing tax distortions arising from redistribution, and it survives for any parametrization of the log-linear tax scheme except for a fully progressive system.
Keywords: Dynamic Optimal Taxation
JEL Codes: E21; E62; H2; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital taxation (H24) | reduction of tax distortions (H21) |
| higher tax progressivity (H29) | lower optimal capital tax rates (H21) |
| demand elasticities (D12) | impact of capital on skill premium (J24) |
| higher share of after-tax skilled labor income in consumption (E25) | higher capital tax (F38) |
| skill bias increases and intertemporal elasticity of substitution significant (J29) | marginal labor tax rate may become negative (H31) |