| Abstract: | This paper analyses the optimal taxation of capital in a stochastically growing small open economy in which there is a perfect market for a traded bond. The analysis emphasizes the dependence of the optimal tax structure upon the policy rule guiding the growth of government expenditure, and its impact on the behaviour of private agents. In general three taxes, reflecting three required conditions, are necessary to attain the first-best optimum. The first is to correct for any externality caused by government expenditure; the second is to attain the optimal portfolio share; the third is to ensure that the government budget constraint is met. |
