Taxing Capital to Protect It

Georgy Lukyanov and Hengrina Ly
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Georgy Lukyanov: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - Comue de Toulouse - Communauté d'universités et établissements de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement

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Abstract: This paper studies the composition of taxation when the government cannot fully commit to respecting private returns after investment. A fiscal authority must finance a given expenditure from labor and capital income. Ordinary tax receipts are protected, but an opportunistic executive can seize part of the remaining capital payment. We show that a revenue-neutral increase in the capital tax raises the probability of compliance whenever the labor tax is below its local, fixedwage revenue peak, provided the equilibrium remains on a regular mixing branch. This result does not depend on the elasticity of substitution between capital and labor. The same reform can raise investment: the gain in expected retention must outweigh the decline in the opportunist's continuation gain as compliance becomes less informative. We also characterize the Ramsey allocation conditional on full compliance. Limited commitment then imposes a ceiling on sustainable capital payments, rather than a general lower bound on the statutory capital-tax rate. Finally, we distinguish a change in the authority's concern for the future from an increase in both actors' patience. The former favors more informative policies when continuation welfare is convex; the latter has no unconditional direction in the reduced-form policy problem.

Keywords: optimal taxation; limited commitment; expropriation risk; government reputation; tax composition; vulnerable tax bases (search for similar items in EconPapers)
Date: 2026-10-19
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Persistent link: https://EconPapers.repec.org/RePEc:hal:wpaper:hal-05805498

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