Publication Type

Journal Article

Publication Date

2-2016

Abstract

When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two-period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks and the degree of heterogeneity among consumers' income, as well as on the way in which the tax revenue is used to provide lump-sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However, in other cases a negative tax on capital is welfare-improving.

Keywords

optimal linear taxes, incomplete markets, constrained efficiency

Discipline

Economic Theory | Finance

Research Areas

Economic Theory

Publication

Journal of Public Economic Theory

Volume

18

Issue

1

First Page

1

Last Page

28

ISSN

1097-3923

Identifier

10.1111/jpet.12135

Publisher

Wiley

Creative Commons License

Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

Additional URL

http://dx.doi.org/10.1111/jpet.12135

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