Capital income taxation,tax criteria,and intergenerational welfare

In a two-period overlapping-generations model, residence criteria are shown to be optimal with lump-sum transfers to the younger generation in a dynamically efficient open economy even if all wage income, corresponding to rent income under exogenous labor supply, is not taxed away. When tax revenues are also distributed to the older generation — which indeed may be desirable for short-term intergenerational welfare distribution reasons — a weighted average rule is derived for optimal international taxation. The taxation of domestic savings income follows the inverse elasticity rule in respect to savings and, surprisingly, higher investment elasticity increases the tax level. Finally, for a small open economy and for large identical economies, tax competition with a mixed scheme of residence-based taxes and source-based subsidies yields the same tax policy as tax cooperation with no restrictions on the domestic and international capital income tax instruments.     

A general-equilibrium intertemporal model of an open economy

Summary This paper develops a very general (general-equilibrium) intertemporal model of a country engaged in international trade which can be used to address a wide variety of issues of interest — in particular, econometric application — under the assumption that prices of tradable commodities (consumer goods and capital goods) and the interest rate are exogenous to the country. It allows for an arbitrarily large number of commodities which are distinguished into seven categories and for finite or infinite periods of time. This model can be used to draw various policy conclusions. We investigate how current net imports, the balance of payments on current account, current consumption expenditure, next-period bondholdings, current wealth, and current internal prices will react to exogenous changes in current external prices, the current interest rate, current taxes, current factor endowments, and current-period bondholdings. This paper also considers the integrability of net-import demand functions.Work supported by National Science Foundation grant SES-8607652. We wish to thank the editor and an anonymous referee for useful comments and suggestions.     

Stabilization mechanisms in a monetary union

The stability of a monetary union entails the establishment of mechanisms that allow the member countries to smooth their paths of consumption after negative shocks in their income. A centralized fiscal institution could help countries through a mechanism of taxes and transfers. In this paper we study the stabilizing effects of different mechanisms of compensation in a two-country general equilibrium model subject to asymmetric technology shocks. In particular, we have focused on an optimal system of taxes and transfers as opposed to a discretionary transfer mechanism, finding that the optimal transfer consists in an intertemporal distribution to the economy that experiences the negative shock instead of a current high transfer as in the non-optimal mechanism. Lastly, we have assessed the degree of stabilization related to the mechanisms in question, showing that the optimal mechanism can match the degree of stabilization the empirical literature attributes to the case of the United States.     

Growth Effects of Taxation Under Altruism and Low Elasticity of Intertemporal Substitution

An increase in the tax rate on capital income may raise the rate of economic growth when the elasticity of intertemporal substitution is low and intergenerational transfers are absent. Since the strength of the bequest motive depends on tax rates, this paper provides conditions under which taxing capital income, and then reducing the labour income tax, is more growth enhancing than the classical policy of zero taxes on capital income, and vice versa.     

Politico-economic cycles of regulation and deregulation

This paper considers politico-economic cycles that do not depend on the exogenous electoral cycles. More precisely, the paper develops a positive model of intertemporal subsidy strategies for an authoritarian and dynastic government. It will be shown — applying the Hopf bifurcation theorem — that cyclical strategies, i.e. waves of regulation, populism alternating with deregulation, cuts in social programmes, etc., may be optimal.     

Reconciling sustainability and discounting in Cost–Benefit Analysis: A methodological proposal

The incorporation of the intergenerational equity objective has rendered the traditional Cost–Benefit Analysis (CBA) approach obsolete for the evaluation of projects presenting an important number of environmental externalities and for those whose impacts extend throughout a long period of time.Based on the assumption that applying a discount rate rewards current consumption and, therefore, that it is only possible to introduce a certain intergenerational equity in a Cost–Benefit Analysis, in this work we propose an approach to discounting based on a different rationale for tangible and intangible effects. We designed two indicators of environmental profitability: a) the Intergenerational Transfer Amount (ITA), which quantifies in monetary units what the current generation is willing to pass on future generations when an environmental restoration project is carried out, and b) the Critical Environmental Rate (CER), measures the implicit environmental profitability.These concepts were tested through an empirical case study pertaining to the assessment of an Erosion Control Project in the southeast of Spain. The results yield traditional profitability indicators that are higher — and probably closer — to the real values set by the contemporary society. The information provided by the environmental profitability indicators proposed renders more transparency to the quantification of the levels of intergenerational equity applied, thereby facilitating the difficult reconciliation of the CBA technique with the objective of sustainability.     

On the possibility of attaining environmental and trade objectives simultaneously

With the greening of political debate around the world, large nations — precluded from using trade instruments explicitly — have become aware of the fact that they can manipulate their domestic tax structure to attain environmental and trade objectives simultaneously. In this note we show how such nations can attain these two targets with one instrument. Specifically, we show how to construct dual purpose taxes. We then focus on the empirical determinants of these taxes.     

On the Intergenerational Incidence of Wage and Consumption Taxes

This paper identifies the conditions that determine the intergenerational incidence of wage and consumption taxes. It emphasizes the role of the households' age‐earnings and age‐consumption profiles for an understanding of various intergenerational incidence patterns. Furthermore, the paper considers some political economy implications of the intergenerational incidence of wage and consumption taxes. It demonstrates that the distributional impact of wage versus consumption taxes bears the potential of a conflict between the young and the old on the one side and the middle‐aged on the other.     

Nonseparable preferences and optimal social security systems

In this paper, we consider economies in which agents are privately informed about their skills, which evolve stochastically over time. We require agents' preferences to be weakly separable between the lifetime paths of consumption and labor. However, we allow for intertemporal nonseparabilities in preferences like habit formation. In this environment, we derive a generalized version of the Inverse Euler Equation and use it to show that intertemporal wedges characterizing optimal allocations of consumption can be strictly negative. We also show that preference nonseparabilities imply that optimal differentiable asset income taxes are necessarily retrospective in nature. We show that under weak conditions, it is possible to implement a socially optimal allocation using a social security system in which taxes on wealth are linear, and taxes/transfers are history-dependent only at retirement. The average asset income tax in this system is zero.     

Resource taxation with heterogeneous quality and endogenous reserves

This paper analyzes the impact of mining taxation on the intertemporal extraction profile for a heterogeneous ore body. The extraction profile specifies both quantities and qualities extracted in each period. Total extraction is thus endogenously determined. The taxes explicitly considered are severance taxes (ad valorem or per unit; on metal or on ore), property taxes, and profits taxes (with depletion allowance). The intertemporal framework integrates economic and geological factors, generating new results on extraction distortions and providing qualification or reconciliation of previous diverse results in this area.     

Taxation of capital income in overlapping generations economies

Whether capital income should be taxed in overlapping generations economies is vividly discussed. It is shown that intergenerational lump‐sum taxes cannot implement the Golden Rule allocation when agents have private information on their earnings potential. Hence, the seminal Atkinson–Stiglitz result that optimal income taxation pre‐empts any role for indirect taxation cannot be interpreted to imply that capital income taxation (affecting intertemporal relative prices) should not be taxed. Specifically, capital income should unambiguously be taxed in small open economies, and the optimal tax rate depends inversely on the elasticity of total savings to disposable income and the after‐tax rate of return.     

Sustainable Forestry: Timber Bequests, Future Generations and Optimal Tax Policy

This paper analyzes harvesting and timber bequest behavior in a two-period overlapping generations model where the government uses site productivity, yield and inheritance taxation. The ceteris paribus effects of forest and inheritance taxes are derived first, then the paper discusses the optimal design of forest and inheritance taxes by assuming that intergenerational externalities are either absent or operative. In the absence of intergenerational externalities, it is optimal to use only the site productivity tax, and not to introduce yield and inheritance taxes at all. In the presence of intergenerational externalities the situation changes. The paper demonstrates that the externality can be internalized by introducing either a yield tax or an inheritance subsidy, or both. If the government is able to use both at the same time, it is desirable to use the yield tax to 'punish' excessive harvesting and an inheritance subsidy to 'bribe' to give bequests.     

Consumption adaptation,anticipation‐bias,and optimal income taxation

Adaptation is omnipresent but people systematically fail to correctly anticipate the degree to which they adapt, leading them to make irrational intertemporal decisions. This paper concerns optimal income taxation to correct for such anticipation‐biases in a framework where consumers adapt to earlier consumption levels. The analysis is based on a general equilibrium OLG model with endogenous labor supply and savings where each consumer lives for three periods. The results show how a paternalistic government may correct for the effects of anticipation‐bias through a combination of time‐variant marginal labor income taxes and savings subsidies/taxes. The optimal policy mix remains the same, irrespective of whether consumers commit to their original life time plan for work hours and consumption or reoptimize later on when realizing that they have already adapted more than expected.     

Optimal taxation and discount rate for public investment in a growth setting

This paper studies the optimal policy of a government which maximizes intertemporal social welfare using such instruments as taxes on interest income and wages, and debt in conjunction with public investment. In doing so, it has to face a decentralized economy where in each generation individuals and firms are free to maximize their own objectives subject to their own private constraints. The welfare function is a sum of discounted generational utilities and its maximization is handled by using dynamic programming. From the first order conditions so derived, it appears that an optimal policy of taxation and public capital accumulation is that which sets the tax rates according to Ramsey's optimal taxation structure and which equates the rate of return on public investment to the rate of social time preference.     

Markovian Social Security in Unequal Societies

In this paper, we develop a dynamic political‐economic theory of social security. We analytically characterize a Markov perfect equilibrium and find that the interaction between Markovian tax policy and tax distortion on private investment in human capital shapes an intertemporal policy rule, linking taxes positively over time. By allowing current taxpayers to influence their own future social security benefits, the positive intertemporal tax linkage provides political support for social security. Moreover, this positive tax linkage leads to a negative correlation between wage inequality and the size of a nation's social security system, consistent with the empirical pattern observed across OECD countries.     

Intertemporal Budget Policies and Macroeconomic Adjustment in Indebted Open Economies

This paper analyzes the role of government intertemporal budget policies in a growing open economy including nominal assets in the presence of an upward sloping supply of debt. This introduces transitional dynamics that influence the effects of government policy instruments on economic growth and the long term fiscal liability. It is shown that capital income taxes or a combination of tax‐cum‐expenditure or government expenditure alone can balance the long term intertemporal government budget constraint. However, those results are shown to depend critically upon the extent of distortion in capital flows brought about the upward sloping supply of debt.     

Globalisation, capital mobility and tax competition: theory and evidence for OECD countries

Are the predictions of tax competition theory wrong? While the tax competition literature predicts that taxes on income from capital decrease with increasing globalisation, past empirical studies on various data find contradicting evidence. By using different data and additional elements of economic theory, this paper aims to challenge the empirical contributions. For a panel of 14 OECD countries and for the period 1967–1996, we find that globalisation has indeed a negative and significant impact on corporate taxes. Furthermore, globalisation tends to raise labour taxes and social expenditures. As a consequence, the so-called “efficiency” and “compensation” hypotheses of globalisation are not competing, but rather, both appear to apply at the same time. Efficiency has an impact on the tax-mix, whereas compensation is provided through increased social expenditures.     

Environmental quality,the macroeconomy,and intergenerational distribution

The paper studies the dynamic allocation effects and intergenerational welfare consequences of environmental taxes. To this end, environmental externalities are introduced in a Blanchard–Yaari overlapping generations model of a small open economy. A rise in environmental taxes – taking into account pre-existing distortionary taxes and endogenous labor supply – is shown to yield an efficiency gain if agents care enough for the environment. The benefits are unevenly distributed across generations because agents are heterogeneous in their capital ownership. An accompanying debt policy can be designed – prescribing debt accumulation at impact and debt redemption in the new steady state – to ensure everybody gains to the same extent. With lump-sum recycling of environmental tax revenue, aggregate employment is unaffected in the short run, but falls in the long run. Furthermore, it raises environmental quality more in the long run than in the short run. Recycling revenue through a cut in labor taxes, however, is shown to yield a rise in employment in the short run, which disappears during transition. In the new steady state, environmental quality is higher at the expense of a lower level of employment.     

Investment subsidies and redistributive capital income taxation in a neoclassical growth model

How do investment subsidies bear on pure redistribution when coupled with capital income taxes? In a heterogeneous agent, neoclassical growth framework it is found that on impact, with no optimizing behavior, investment subsidies are good for growth but bad for redistribution. The opposite holds for capital income taxes. But when the government acts as a Stackelberg leader vis-à-vis the private sector (the follower), the optimal feedback policy is by construction time-consistent and implies that in a long-run optimum the tax scheme does not distort accumulation. This holds regardless of social preferences. For the feedback Stackelberg equilibrium I find that (pure) redistribution can go either way and capital income taxes are nonzero in the long-run, time-consistent optimum, depending on the social weight of those who receive redistributive transfers, the distribution of pretax factor incomes, and the intertemporal elasticity of substitution. It is argued that investment subsidies may be an important indirect tool for redistribution, and may allow for the separation of “efficiency” and “equity” concerns.     

Tax competition,tax coordination and tax harmonization: The effects of EMU

There is little doubt that the step towards a monetary union in Europe will increase both the distorionary effects of existing differences in national tax systems and the intensity of tax competition for internationally mobile commodity and factor tax bases. This paper discusses selected issues of commodity and capital tax coordination that are likely to be affected by monetary unification. Starting from the distortive present scheme of value-added taxation in Europe we first analyze the effects of a switch to a general origin-based VAT as a way to maintain national tax rate autonomy over this important tax base. While an origin-based VAT would neither distort trade flows — both within the EU and with third countries — nor investment decisions in the long-run, its short-run effects are likely to be severe in the absence of exchange rate flexibility. In the field of capital taxation the focus switches to the feasibility of regional harmonization measures when there is no cooperation with the rest of the world. We argue that in a monetary union the mobility costs of capital will be significantly lower within the EU as compared to outside investments. This provides an efficiency argument for minimum source taxes on both interest income and corporate profits even if cooperation with third countries is infeasible.