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AN EVALUATION OF CONSTITUTIONAL CONSTRAINTS ON CAPITAL TAXATION

Published online by Cambridge University Press:  10 August 2016

Begoña Domínguez  and
Zhigang Feng
Begoña Domínguez*
Affiliation:
The University of Queensland
Zhigang Feng
Affiliation:
University of Illinois at Urbana–Champaign and University of Nebraska at Omaha
*
Address correspondence to: Begoña Domínguez, School of Economics, University of Queensland, Colin Clark Building (39), St Lucia, Brisbane, Queensland 4072, Australia; e-mail: b.dominguez@uq.edu.au.
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Abstract

This paper investigates the desirability of constitutional constraints on capital taxation in an environment without government debt and where benevolent governments have limited commitment. In our setup, governments can choose proportional capital and labor income taxes subject to the constitutional constraint but cannot commit to an actual path of taxes. First, we explore a form of constitutional constraint: a constant cap on capital tax rates. In our quantitative exercise, we show that a three percent cap on capital taxes provides the highest welfare at the worst sustainable equilibrium. However, such a cap decreases welfare at the best sustainable equilibrium (both because it constrains feasibility and because it tightens the incentive compatibility constraint). Second, we identify a form of constitutional constraint that can improve all sustainable equilibria. That constraint features a cap on capital taxes that increases with the level of capital.

Keywords

Optimal PolicyRules vs. DiscretionTime Consistency
Type
Articles
Information
Macroeconomic Dynamics , Volume 21 , Issue 7 , October 2017 , pp. 1519 - 1544
Copyright
Copyright © Cambridge University Press 2016 

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Footnotes

We would like to thank the editor and two anonymous referees for very helpful comments. We also thank Pedro Gomis-Porqueras, Kenneth Judd, Felix Kübler, and useful comments at several presentations. Zhigang Feng acknowledges financial support from NCCR-FINRISK, and computational support from David Kelly, Zongjun Hu, and CCS at University of Miami. All the remaining errors are ours.

References

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