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Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk

Dirk Krueger () and Alexander Ludwig ()

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

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.

Keywords: Idiosyncratic Risk; Taxation of Capital; Overlapping Generations; Precautionary Saving; Pecuniary Externality (search for similar items in EconPapers)
JEL-codes: H21 H31 E21 (search for similar items in EconPapers)
Pages: 80 pages
Date: 2018-02-09, Revised 2018-02-09
New Economics Papers: this item is included in nep-gro, nep-mac, nep-pbe and nep-upt
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Related works:
Working Paper: Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk (2019) Downloads
Working Paper: Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk (2018) Downloads
Working Paper: Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk (2018) Downloads
Working Paper: Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk (2018) Downloads
Working Paper: Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk (2018) Downloads
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