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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 Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt

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)
New Economics Papers: this item is included in nep-dge, nep-gro, nep-mac, nep-pbe, nep-pub and nep-upt
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
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Related works:
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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