The marginal welfare cost of capital taxation: Discounting matters

Marika Santoro and Chao Wei

Journal of Economic Dynamics and Control, 2013, vol. 37, issue 4, 897-909

Abstract: We interpret the marginal welfare cost of capital income taxes as the present discounted value of consumption distortions. Such an asset market interpretation emphasizes the importance of the interest rate used to value future distortions, especially in the presence of uncertainty. We find that the interest rate decreases as the tax rate increases, thus increasing the welfare cost. The variations in the interest rate are caused by amplified responses of consumption to exogenous shocks as a result of capital taxation. The welfare cost may be underestimated if variations in interest rates are ignored, especially when tax rates are high.

Keywords: Welfare cost; Capital income taxes; Asset market (search for similar items in EconPapers)
JEL-codes: E22 E44 E62 H25 (search for similar items in EconPapers)
Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:37:y:2013:i:4:p:897-909

DOI: 10.1016/j.jedc.2012.12.006

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