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Optimal Capital Taxation and Consumer Uncertainty

Ryan Chahrour and Justin Svec ()

No 854, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: This paper analyzes the impact of consumer uncertainty on optimal fiscal policy in a model with capital. The consumers lack confidence about the probability model that characterizes the stochastic environment and so apply a max-min operator to their optimization problem. An altruistic fiscal authority does not face this Knightian uncertainty. We show analytically that, in responding to consumer uncertainty, the government no longer sets the expected capital tax rate exactly equal to zero, as is the case in the full-confidence benchmark model. Rather, our numerical results indicate that the government chooses to subsidize capital income, albeit at a modest rate. We also show that the government responds to consumer uncertainty by smoothing the labor tax across states and by making the labor tax persistent.

Keywords: Model uncertainty; capital income tax; public debt (search for similar items in EconPapers)
JEL-codes: E62 H21 (search for similar items in EconPapers)
Date: 2014-04-01
New Economics Papers: this item is included in nep-acc, nep-dge, nep-mac, nep-pbe and nep-pub
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Forthcoming, Journal of Macroeconomics

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Related works:
Journal Article: Optimal capital taxation and consumer uncertainty (2014) Downloads
Working Paper: Optimal Capital Taxation and Consumer Uncertainty (2011) Downloads
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