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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing
Nina Biljanovska
Alexandros Vardoulakis
Abstract

We study optimal long-run capital taxation in a closed economy with heterogeneity in agents' time-discount factors where borrowing is allowed but restricted by a collateral constraint. Financial frictions distort intertemporal optimization margins and the tax system serves a dual role: first, it is used to finance government consumption; second, it serves to alleviate the distortions arising from the binding collateral constraint. The discrepancy between the private and the social discount factors pushes for a subsidy on capital, while the discrepancy introduced by the collateral constraint pushes for a tax in the long-run. When consumption smoothing motives are muted, the two effects counter-balance each other and the tax is zero. With finite elasticity of intertemporal substitution, the second discrepancy dominates and the tax on capital income is positive in the long-run.


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Nina Biljanovska & Alexandros Vardoulakis, Capital Taxation with Heterogeneous Discounting and Collateralized Borrowing, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2017-053, 05 May 2017.
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Keywords: Ramsey taxation ; Collateral constraint ; Heterogeneous discount factors ; Tax on capital
DOI: 10.17016/FEDS.2017.053
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