Marco Cozzi from the University of Victoria will be presenting his paper, “Optimal Capital Taxation with Incomplete Markets and Schumpeterian Growth”, next Monday, November 4th, from 2:00 PM to 3:30 PM in PLZ410. Please find the abstract below. Join us!

Abstract

In this paper, I characterize quantitatively the optimal capital income tax rate in an OLG economy with uninsurable income risk, incomplete markets and endogenous Schumpeterian growth. Contrary to the most recent literature, I find that it is virtually never optimal to tax capital. Under the optimal scheme, the highest proportional tax rate on capital is found to be less than 0.2%. The reason for this result lies in the reduced GDP (and wage) growth rate stemming from a higher capital tax rate. In General Equilibrium, the interest rate rises, and the increased cost of capital reduces the endogenous rate of innovation, leading to a negative response of the growth rate. Although the equilibrium effect on the growth rate is found to be quantitatively modest (approximately half a percentage point), it still has a first order consequence on welfare. The results show that moving to the optimal income tax schedule entails large welfare gains, approximately 5% in consumption equivalent. These large effects are also explained by a large reduction in the monopolistic distortions: in the intermediate goods sector, the mark-up over the marginal costs falls by more than 10 percentage points. The results are robust along a number of dimensions, including the specification of preferences.