NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Capital Taxation and Ownership when Markets are Incomplete

Emmanuel Farhi

NBER Working Paper No. 13390
Issued in September 2007
NBER Program(s):   EFG   PE

This paper analyzes the theoretical and quantitative implications of optimal capital taxation in the neoclassical growth model with aggregate shocks and incomplete markets. The model features a representative-agent economy with proportional taxes on labor and capital. I first consider the case that the only asset the government can trade is a real risk-free bond. Taxes on capital are set one period in advance, reflecting inertia in tax codes and ruling out replication of the complete markets allocation. Because capital income varies with the state of the economy, capital taxation provides a state contingent source of revenues. I thus identify a novel potential role for capital taxation as a risk sharing instrument between the government and private agents. However, this benefit must be weighted again the distortionary cost of capital taxation. For a baseline case, the optimal policy features a zero tax on capital. Moreover, numerical simulations show that the baseline case provides an excellent benchmark. I next allow the government to hold a non trivial position in capital. Capital ownership provides the same benefit or risk sharing but without the cost of tax distortions. In a variety of quantitative exercises, I show that capital ownership allows the government to realize about 90% of the welfare gains from moving to complete markets. Large positions are typically required for optimality. But smaller positions achieve substantial benefits. In a business-cycle simulation, I show that a 15% short equity position achieves over 40% of the welfare gains from completing markets.

download in pdf format
   (552 K)

email paper

This paper is available as PDF (552 K) or via email.

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX

Published: Emmanuel Farhi, 2010. "Capital Taxation and Ownership When Markets Are Incomplete," Journal of Political Economy, University of Chicago Press, vol. 118(5), pages 908 - 948.

Users who downloaded this paper also downloaded these:
Gale and Slemrod w8205 Rethinking the Estate and Gift Tax: Overview
Kopczuk w15741 Economics of estate taxation: a brief review of theory and evidence
Chetty and Szeidl w15998 The Effect of Housing on Portfolio Choice
Farhi and Werning w18381 Fiscal Multipliers: Liquidity Traps and Currency Unions
Butler, Giuliano, and Guiso w15344 The Right Amount of Trust
 
Publications
Activities
Meetings
Data
People
About

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

Contact Us