Country-Specific Dynamic Optimal Capital Income Tax Rate

Abstract

The empirical tax rate on capital income ranges between 0.4 and 0.6 in OECD countries. This paper presents the optimal taxation problem in an one-sector dynamic general equilibrium model where the government is confronted with fiscal constraint (the ratio of government expenditure to GDP is exogenously given) while households and firms do not recognize the fiscal constraint. We derive analytically the positive optimal tax rates on capital income. Under the fiscal constraint, the optimal tax rate on capital income depends on the discount rate, the rate of capital depreciation, and the ratio of government spending to GDP. Our model can generate the country-specific optimal tax rate on capital income (0.2 to 0.4). Thus, this paper insists that the empirical data of tax rates in OECD countries are higher than the results predicted by our model.