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Pareto-improving optimal capital and labor taxes (2008)
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@MISC{Greulich08pareto-improvingoptimal,
author = {Katharina Greulich and Albert Marcet},
title = { Pareto-improving optimal capital and labor taxes },
year = {2008}
}
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Abstract
We show a standard model where the optimal tax reform is to cut labor taxes and leave capital taxes very high in the short and medium run. Only in the very long run would capital taxes be zero. Our model is a version of Chamley’s, with heterogeneous agents, without lump sum transfers, an upper bound on capital taxes, and a focus on Pareto improving plans. For our calibration labor taxes should be low for the first ten to twenty years, while capital taxes should be at their maximum. This policy ensures that all agents benefit from the tax reform and that capital grows quickly after when the reform begins. Therefore, the long run optimal tax mix is the opposite from the short and medium run tax mix. The initial labor tax cut is financed by deficits that lead to a positive long run level of government debt, reversing the standard prediction that government accumulates savings in models with optimal capital taxes. If labor supply is somewhat elastic benefits from tax reform are high and they can be shifted entirely to capitalists or workers by varying the length of the transition. With inelastic labor supply there is an increasing part of the equilibrium frontier, this means that the scope for benefitting the workers is limited and the total benefits from reforming taxes are much lower.
Keyphrases
labor tax pareto-improving optimal capital capital tax tax reform optimal capital tax equilibrium frontier first ten long run optimal tax mix capital grows labor supply medium run tax mix standard model government debt long run total benefit positive long run level calibration labor tax upper bound inelastic labor supply standard prediction heterogeneous agent elastic benefit optimal tax reform initial labor tax cut medium run lump sum transfer
