Taxing Capital? Not a Bad Idea After All!

Juan Carlos Conesa, Sagiri Kitao, Dirk Krueger

NBER Working Paper No. 12880
Issued in January 2007
NBER Program(s):   EFG   PE

In this paper we quantitatively characterize the optimal capital and labor income tax in an overlapping generations model with idiosyncratic, uninsurable income shocks, where households also differ permanently with respect to their ability to generate income. The welfare criterion we employ is ex-ante (before ability is realized) expected (with respect to uninsurable productivity shocks) utility of a newborn in a stationary equilibrium. Embedded in this welfare criterion is a concern of the policy maker for insurance against idiosyncratic shocks and redistribution among agents of different abilities. Such insurance and redistribution can be achieved by progressive labor income taxes or taxation of capital income, or both. The policy maker has then to trade off these concerns against the standard distortions these taxes generate for the labor supply and capital accumulation decision. We find that in our model the optimal capital income tax rate is significantly positive. The optimal (marginal and average) tax rate on capital is 36%, in conjunction with a progressive labor income tax code that is, to a first approximation, a flat tax of 23% with a deduction that corresponds to about $6,000 (relative to an average income of households in the model of $35,000). We argue that the high optimal capital income tax is mainly driven by the life cycle structure of the model whereas the optimal progressivity of the labor income tax is due to the insurance and redistribution role of the income tax system.

download in pdf format
   (366 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w12880

Published: Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2009. "Taxing Capital? Not a Bad Idea after All!," American Economic Review, American Economic Association, vol. 99(1), pages 25-48, March. citation courtesy of

Users who downloaded this paper also downloaded* these:
Mankiw, Weinzierl, and Yagan w15071 Optimal Taxation in Theory and Practice
Lichtenberg w9139 The Effect of Changes in Drug Utilization on Labor Supply and Per Capita Output
Chor and Freeman w11598 The 2004 Global Labor Survey: Workplace Institutions and Practices Around the World
Conesa and Krueger w11044 On the Optimal Progressivity of the Income Tax Code
Heathcote, Storesletten, and Violante w14768 Quantitative Macroeconomics with Heterogeneous Households
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us