SSE/EFI Working Paper Series in Economics and Finance
No 372:
Factor Taxation with Heterogeneous Agents
David Domeij ()
and Jonathan Heathcote
Abstract: We investigate the welfare implications of changing a
proportional capital income tax for a model economy in which heterogeneous
households face labor income risk and trade only one asset. Labor taxes are
adjusted at the time of the reform to maintain long run budget balance. Our
stochastic process for labor earnings is consistent with empirical
estimates of earnings risk, and also implies a distribution of asset
holdings across households closely resembling that in the United States.
We find that a vast majority of households prefers the status quo to
eliminating capital taxes. This finding is interesting in light of the fact
that this reform would be optimal if we abstracted from heterogeneity and
assumed a representative agent. A second finding is that in the incomplete
markets economy, a utilitarian government prefers the current calibrated
U.S. capital income tax rate (39.7 percent) to any change in the capital
tax rate. If markets were complete, on the other hand, average welfare
would be maximized by reducing the capital tax rate to around 30
percent.
Keywords: Factor taxation; redistribution; heterogeneous agents; (follow links to similar papers)
JEL-Codes: E62; H21; H31; (follow links to similar papers)
32 pages, March 30, 2000
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