TY - JOUR AU - Conesa,Juan Carlos AU - Kitao,Sagiri AU - Krueger,Dirk TI - Taxing Capital? Not a Bad Idea After All! JF - National Bureau of Economic Research Working Paper Series VL - No. 12880 PY - 2007 Y2 - January 2007 UR - http://www.nber.org/papers/w12880 L1 - http://www.nber.org/papers/w12880.pdf N1 - Author contact info: Juan Carlos Conesa Universitat Autonoma de Barcelona Department of Economics Edifici B, Campus Bellaterra 08193 Cerdanyola del Valles, SPAIN Tel: 34 935813210 Fax: 34 935812012 E-Mail: juancarlos.conesa@uab.es Sagiri Kitao Federal Reserve Bank of New York 33 Liberty Street New York, NY 10045 E-Mail: sagiri.kitao@gmail.com Dirk Krueger Department of Economics University of Pennsylvania 3718 Locust Walk Philadelphia, PA 19104 Tel: 215/898-6691 Fax: 215/573-2057 E-Mail: dkrueger@econ.upenn.edu M3 - presented at "SI 2006 EFG Working Group (EFACR)", July 17-21, 2006 AB - 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. ER -