Optimal capital taxation for time-nonseparable preferences

Koehne, Sebastian and Kuhn, Moritz (2013): Optimal capital taxation for time-nonseparable preferences.

Abstract

This paper studies the effect of habit formation on optimal capital taxes in a dynamic Mirrleesian model. We make three distinct contributions. First, we decompose intertemporal wedges (implicit capital taxes) for general time-nonseparable preferences into a wealth effect, a complementarity effect, and a future incentive effect. Second, we provide conditions under which intertemporal wedges are positive. Third, we derive a recursive formulation of constrained efficient allocations and evaluate the quantitative impact of habit formation. In a model parameterized to the U.S. economy, habit formation reduces average intertemporal wedges by about 40 percent compared to the time-separable case. Moreover, intertemporal wedges are close to zero for the largest part of the working life.

• Item Type: MPRA Paper
• Language: English
• Keywords: optimal taxation; intertemporal wedge; habit formation; recursive contracts; new dynamic public finance
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E21 - Consumption ; Saving ; Wealth; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency ; Optimal Taxation

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