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

Dirk Krueger and Alexander Ludwig

No 201, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

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 effects of private precautionary saving on factor prices. For logarithmic utility a complete analytical solution of the Ramsey problem exhibits an optimal aggregate saving rate that is independent of income risk, whereas the optimal time-invariant tax on capital implementing this saving rate is increasing in income risk. The optimal saving rate is constant along the transition and its sign depends on the magnitude 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 induces a Pareto-improving transition even if the initial equilibrium is dynamically efficient. For general Epstein-Zin-Weil utility we 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.

Keywords: Idiosyncratic Risk; Taxation of Capital; Overlapping Generations; Precautionary Saving; Pecuniary Externality (search for similar items in EconPapers)
JEL-codes: E21 H21 H31 (search for similar items in EconPapers)
Date: 2019, Revised 2019
New Economics Papers: this item is included in nep-dge, nep-gro, nep-mac, nep-pbe, nep-pub and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk (2021)
Working Paper: Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk (2021)
Working Paper: Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk (2018)
Working Paper: Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk (2018)
Working Paper: Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk (2018)
Working Paper: Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:201

DOI: 10.2139/ssrn.3124792

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