Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk


Krueger, Dirk ; Ludwig, Alexander


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URL: https://ub-madoc.bib.uni-mannheim.de/44854
URN: urn:nbn:de:bsz:180-madoc-448541
Document Type: Working paper
Year of publication: 2018
The title of a journal, publication series: ZEW Discussion Papers
Volume: 18-014
Place of publication: Mannheim
Publication language: English
Institution: Sonstige Einrichtungen > ZEW - Leibniz-Zentrum für Europäische Wirtschaftsforschung
MADOC publication series: Veröffentlichungen des ZEW (Leibniz-Zentrum für Europäische Wirtschaftsforschung) > ZEW Discussion Papers
Subject: 330 Economics
Classification: JEL: H21 , H31 , E21,
Keywords (English): Idiosyncratic risk , taxation of capital , overlapping generations , precautionary saving , pecuniary externality
Abstract: We characterize the optimal linear tax on capital in an Overlapping Generations model with two period lived households facing uninsurable idiosyncratic labor income risk. The Ramsey government internalizes the general equilibrium feedback of private precautionary saving. For logarithmic utility our full analytical solution of the Ramsey problem shows that the optimal aggregate saving rate is independent of income risk. The optimal time-invariant tax on capital is increasing in income risk. Its sign depends on the extent of risk and on the Pareto weight of future generations. If the Ramsey tax rate that maximizes steady state utility is positive, then implementing this tax rate permanently generates a Pareto-improving transition even if the initial equilibrium is dynamically efficient. We generalize our results to Epstein-Zin-Weil utility and show that the optimal steady state saving rate is increasing in income risk if and only if the intertemporal elasticity of substitution is smaller than 1.

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Krueger, Dirk ; Ludwig, Alexander (2018) Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk. Open Access ZEW Discussion Papers Mannheim 18-014 [Working paper]
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