Working Paper: CEPR ID: DP5929
Authors: Juan Carlos Conesa; Sagiri Kitao; Dirk Kruger
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: Capital Taxation; Optimal Taxation; Progressive Taxation
JEL Codes: E62; H21; H24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Optimal capital income tax (H21) | Capital accumulation (E22) |
| Optimal capital income tax (H21) | Labor supply elasticity (J20) |
| Household preferences regarding leisure (D13) | Optimal capital income tax (H21) |
| Optimal capital income tax (H21) | Saving behavior of middle-aged individuals (D14) |
| Life cycle structure of model (E10) | Optimal capital income tax (H21) |
| Optimal progressivity of labor income tax (H21) | Insurance and redistribution among households (G52) |