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AN EVALUATION OF CONSTITUTIONAL CONSTRAINTS ON CAPITAL TAXATION

  • Begoña Domínguez (a1) and Zhigang Feng (a2)
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.

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Corresponding author
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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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.

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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
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