Working Paper: NBER ID: w29961
Authors: Corina Boar; Matthew P. Knowles
Abstract: We study optimal taxation in a model with endogenous financial frictions, risky investment and occupational choice, where the wealth distribution affects how efficiently capital is used. The planner chooses linear taxes on wealth, capital and labor income to maximize the steady state utility of a newborn agent. Most agents in the model are poor, leading to an equity motive for taxation. We calibrate the model to the US economy and find low positive levels of optimal capital income and wealth taxes. We express optimal tax rates as a closed-form function of the size of tax bases and their elasticities with respect to tax rates, highlighting the forces behind the result. Because financial frictions are endogenous, higher capital income tax rates tighten financial frictions and reduce output. Thus, optimal capital income taxes are lower than in models with exogenous frictions.
Keywords: Optimal Taxation; Entrepreneurship; Financial Frictions; Capital Income Tax; Wealth Tax
JEL Codes: E2; E6; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher capital income tax rates (F38) | Tighter financial frictions (F65) |
| Tighter financial frictions (F65) | Reduced output (E23) |
| Higher capital income tax rates (F38) | Reduced output (E23) |
| Taxes (H29) | Allocation of capital between risky and risk-free technologies (D29) |
| Taxes (H29) | Entrepreneurial investment decisions (G31) |
| Optimal taxation (H21) | Understanding of tax rates impact on economic behavior (H32) |
| Optimal capital income taxes (H21) | Lower than in models with exogenous frictions (E19) |