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The Effect of Capital Taxation on Capital Accumulation and Welfare

By Begoña Domínguez and Zhigang Feng


This paper analyzes the effects of time-consistent capital taxation on the level of capital and welfare. We find that a commitment to a zero capital tax shifts the time inconsistency problem towards labor taxes and the provision of public consumption. By comparing the worst time-consistent policies with and without a commitment to zero capital taxes, we find that the mere existence of a capital tax might lead to capital tax rates that are as high as 90 % at steady state and capital stocks that are 84 % lower. There the welfare gains of a commitment to zero capital taxes are about 7.4 % of initial steady state consumption. At the other end, comparing the best time-consistent policies, we find that the welfare losses of a commitment to zero capital taxes are about 0.9 % of consumption

Topics: JEL Codes, E61, E62, H21, H62, H63. Keywords, Optimal Policy, Rules vs. Discretion, Time-Consistency
Year: 2012
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