Intergenerational Allocation of Government Expenditures: Externalities and Optimal Taxation

This paper studies optimal capital and labor income taxes when the benefits of public goods are age‐dependent. Provided the government can impose a consumption tax, it can attain the first‐best resource allocation. This involves the uniform taxation of the cohorts' labor income and a zero capital income tax. With no consumption tax and optimally chosen government spending, labor income should be taxed nonuniformly across cohorts and the capital income tax should be nonzero. Deviations of the public goods from their respective optima create distortions. These affect the labor supply decisions of both cohorts and capital accumulation, providing a further reason to tax (or subsidize) capital income.     

The optimal taxation of risky capital income: An elasticity rule

Should risky capital income be taxed like safe income or should tax rates be differentiated? The question is analyzed in a 2-assets model of portfolio choice. Flat tax rates are chosen in order to maximize the investor's expected utility from terminal wealth subject to an expected tax revenue constraint. If lump-sum taxes are not available, optimal tax rates are characterized by an elasticity rule: The relative change in the risk remuneration should be equal to the inverse of the product of two elasticities. One is the output elasticity of capital. The other is the demand elasticity for risky investments with respect to a revenue preserving tax variation.     

Second-best optimal taxation of capital and labor in a developing economy

As commercial integration reduces the reliance on foreign trade taxation, raising tax revenue has become a major concern for the governments of developing economies. This paper examines how the tax burden in a developing economy should be distributed between capital income and labor income. We study a two-sector model, where the traditional sector is “informal” and consequently cannot be taxed by the government. In this setup, we find that the optimal (second-best) tax structure in order to raise a certain amount of revenue requires to tax capital income at least as much as labor income, and possibly more.     

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.     

Income Shifting within a Dual Income Tax System: Evidence from the Finnish Tax Reform of 1993*

Dual income tax systems can suffer from income that shifts from progressively taxed labour income to capital income, which is taxed at a lower, flat rate. This paper empirically examines the 1993 Finnish dual income tax reform, which radically reduced the marginal tax rates on capital income for some, but not all, taxpayers. We measure how overall taxable income and the relative shares of capital income and labour income reacted to the reform. We find that the reform led to a small positive impact on overall taxable income, but part of the positive response was probably offset by income shifting among the self‐employed.     

Optimal taxes on wealth and consumption in the presence of tax evasion

This article incorporates tax evasion into an optimum taxation framework with individuals differing in earning abilities and initial wealth. We find that despite the possibility of its evasion a tax on initial wealth should supplement the optimal nonlinear income tax, given a positive correlation between initial wealth and earning abilities. Further, even if income and initial wealth are taxed optimally, it is still desirable to levy a tax on commodities, though it can be evaded as well. Thus, our result provides a rationale for a comprehensive tax system. Optimal tax rates on commodities differ in general, however for the special case of a uniform evasion technology equal rates are optimal if preferences are homothetic and weakly separable.     

A Case Against Zero Capital-Income Taxation

This paper develops a dynamic general equilibrium model to investigate the optimal level of capital income taxation in light of stochastic endogenous economic growth. Although endogenous human capital is incorporated into our model, we restrict our investigation to the issue of optimal physical capital income tax; and the labor supply is also endogenously determined. This paper proves that the optimal capital income tax should be zero provided exogenous government expenditure on production; however, capital income should be taxed if we consider endogenous government consumption.     

On the Optimal Taxation in a Growth Model of the Mixed Economy

Previous studies of second‐best taxation have shown that capital income shall not be taxed in the long run for some cases where individuals have infinite lives and a utility function of special form. The present paper improves upon this conclusion in two respects: first, the utility function may be of more general form, and second, zero capital income tax is required for the entire period, which does not depend on whether the individual's horizon is infinite or finite. Furthermore, we also show that the optimal tax rate on capital income should tend to zero in the long run if the first‐best optimum is attainable.     

Optimal income taxation in models with endogenous fertility

This paper studies the efficient taxation of factor income in infinite-lived models with elastic fertility choices. Two models are considered, one with physical capital only, and one with physical and human capital. In the model with physical capital only, capital income should be subsidized, while labor income taxed. In the model with two types of capital, instead, Ramsey optimality prescribes that the tax on physical capital is zero (negative), if effective labor is constant (decreasing) returns to scale in human capital and market goods, while the tax on human capital is negative and the tax on effective labor positive. Our findings depart from those obtained in immortal models with an endogenous labor supply and constant population growth, because physical and human capital affect the demand for fertility.     

Optimal Factor Income Taxation in the Presence of Unemployment

According to conventional wisdom internationally mobile capital should not be taxed or should be taxed at a lower rate than labour. An important underlying assumption behind this view is that there are no market imperfections, in particular that labour markets clear competitively. At least for Europe, which has been suffering from high unemployment for a long time, this assumption does not seem appropriate. This paper studies the optimal factor taxation in the presence of unemployment which results from the union-firm wage bargaining both with optimal and restricted profit taxation when capital is internationally mobile and labour immobile. In setting tax rates the government is assumed to behave as a Stackelberg leader towards the private sector playing a Nash game. The main conclusion is that in the presence of unemployment, the conventional wisdom turns on its head; capital should generally be taxed at a higher rate than labour.     

Constrained Inefficiency and Optimal Taxation with Uninsurable Risks

When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two‐period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks and the degree of heterogeneity among consumers' income, as well as on the way in which the tax revenue is used to provide lump‐sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However, in other cases a negative tax on capital is welfare‐improving.     

Taxation and household portfolio composition: US evidence from the 1980s and 1990s

This paper explores the relationship between household marginal income tax rates, the set of financial assets that households own, and the portfolio shares accounted for by each of these assets. It analyzes data from the 1983, 1989, 1992, 1995, and 1998 Surveys of Consumer Finances and develops a new algorithm for imputing federal marginal tax rates to households in these surveys. The empirical findings suggest that marginal tax rates have important effects on asset allocation decisions. The probability that a household owns tax-advantaged assets, such as tax-exempt bonds or assets held in tax-deferred accounts, is positively related to its tax rate on ordinary income. In addition, the portfolio share invested in corporate stock, which is taxed less heavily than interest bearing assets, is increasing in the household’s ordinary income tax rate. Holdings of heavily taxed assets, such as interest-bearing accounts, decline as a share of wealth as a household’s marginal tax rate increases.     

Foreign direct investment in a world of multiple taxes

Governments impose multiple taxes on foreign investors, though studies of the effect of tax policy on the location of foreign direct investment (FDI) focus almost exclusively on corporate income taxes. This paper examines the impact of indirect (non-income) taxes on FDI by American multinational firms, using affiliate-level data that permit the introduction of controls for parent companies and affiliate industries. Indirect tax burdens significantly exceed the foreign income tax obligations of foreign affiliates of American companies. Estimates imply that 10% higher local indirect tax rates are associated with 7.1% lower affiliate assets, which is similar to the effect of 10% higher income tax rates. Affiliate output falls by 2.9% as indirect taxes rise by 10%, while higher income taxes have more modest output effects. High corporate income tax rates depress capital/labor ratios and profit rates of foreign affiliates, whereas high indirect tax rates do not. These patterns reveal the impact of indirect taxes and suggest the mechanisms by which direct and indirect taxes affect FDI.     

Optimal top marginal tax rates under income splitting for couples

This paper provides formulas for optimal top marginal tax rates when couples are taxed according to income splitting between spouses, consumption is taxed, and the skill distribution is unbounded. Optimal top marginal income tax rates are computed for Germany using a dataset that includes the tax returns of all German top taxpayers. We find that the optimal top marginal tax rate converges to about 2/3 and convergence obtains at income levels that are substantially higher than those currently subject to the actual top tax rate.     

Cross-base tax elasticity of capital gains

This paper studies the cross-base tax elasticity of capital gains realizations to labour income taxes when capital gains are taxed at a separate proportional tax rate. Using a longitudinal panel of over 265 000 individuals in Sweden, this paper shows in a regression kink design that labour income taxes affect capital gains realizations in two ways. An increase in the marginal labour income tax rate increases the likelihood of realizing capital gains and the amount of realized capital gains. One implication of this result is that labour income taxes have a lock-out effect but that the magnitude of this effect is smaller than the lock-in effect of the actual capital gains tax.     

Fiscal policies,frictional labor market,and endogenous growth

This paper considers the spillover effects from public spending, and studies optimal fiscal policies in frictional labor markets. We obtain that the optimal shares of government spending in production and consumption are the same as those in a frictionless labor market under the Hosios condition. However, as higher capital accumulation increases the cost of job creation and maintenance, the optimal tax rate of capital income is positive. In addition, when the labor market is frictional, the marginal benefit of labor is larger than the marginal utility of leisure. Thus, consumption and labor should not be taxed uniformly any more. Our calibration suggests that all of the three tax rates should be positive. Moreover, in the situation in which the Hosios condition does not hold, the shares of public productive spending and public consumption both increase when the worker’s bargaining power is greater than the elasticity of search in the matching function.     

Optimal fiscal policy in the Uzawa-Lucas model with externalities

Summary. This paper devises a fiscal policy by means of which the first-best optimum equilibrium is attained as a market equilibrium in the Uzawa-Lucas model when average human capital has an external effect on productivity. The optimal policy requires the use of a subsidy to investment in human capital which can be financed by a tax on labor income. Lump-sum taxation is not required to balance the government budget either in the steady state or in the transitional phase. Physical capital income should not be taxed. Alternatively, the optimal growth path can be attained by means of a subsidy to human capital. Received: March 21, 2002; revised version: September 4, 2002 RID="*" ID="*" Financial support from the Spanish Ministry of Science and Technology through PNICDYIT grant SEC2002-03663 is gratefully acknowledged.     

Numerical simulation on property tax reform: evidence from China

This article analyses the property tax reform in China in a computable general equilibrium model that recognizes the interaction between and among housing markets in different provinces and macroeconomic development. Using real data in 2010, we present the benchmark equilibrium for reference property and income tax rates. Then, we examine different property and income tax policies and make a comparison of their production, consumption, welfare and national income. We find that the implementation of property tax would decrease the house production at the expense of welfare in taxed area. The expansion of the taxed regions may increase the total social welfare and national income. Even though property tax policy may not be able to change the income distribution in China, increasing income tax rate could narrow the income disparity. Finally, this article shows the reliability of the conclusions when sensitivity analysis on optimal condition of equilibrium computation is performed under varied property tax policy.     

Taxation, Bequests, and Short and Long Run Timber Supplies: An Overlapping Generations Problem

This paper uses an overlapping generations model with one-sided altruism to study the effects of several forest taxes that target bequests and affect timber supply. Unlike previous work, we investigate bequests and timber supply in both the short and long run when bequests are costly (e.g., taxed). The landowner's problem is examined in the short run, while the government's problem is examined in the long run assuming the existence of a steady state. We also consider taxes targeting harvests, growth, savings and bequests. Several new results are established concerning the interactions of taxes that might be used by a government to alter short and long run forest capital stocks: (i) the presence of a forest bequest tax affects the neutrality of harvest tax in both the short and long run, (ii) in the long run the bequest tax decreases bequests and timber supplies. When the bequest tax is not present, the capital income tax is neutral with respect to bequest and timber supply, while the harvest tax is neutral only if forest productivity is also not taxed. Finally, (iii) in the short run, the substitution and total effects of taxes in landowner decisions generally depend on the presence of the bequest tax. The results have implications for Pigouvian tax design and second best tax choice.     

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.