DP4731 On the Optimal Timing of Taxes

Author(s): John Hassler , Per Krusell , Kjetil Storesletten , Fabrizio Zilibotti

Publication Date: November 2004

Keyword(s): optimal taxation , tax dynamics , time-consistency , capital depreciation

JEL(s): D90 , E61 , H21 , H30

Programme Areas: International Macroeconomics , Labour Economics , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP4731.asp

This Paper analyses the optimal timing of taxes on capital income. We show that the celebrated result that taxes should front-loaded with an initially high tax followed by a discrete jump to the steady state is knife-edge, hinging on capital having a constant depreciation rate. An empirically supported deviation from this case, involving depreciation rates that increase over the lifespan of the investment, implies that optimal taxes should oscillate. Furthermore, the optimality of fluctuating tax rates hinges on the government being able to commit to the path of future tax rates. Without commitment, optimal taxes may be smooth also under accelerating depreciation. In a calibrated example, we find that optimal taxes are oscillating under commitment and smooth without commitment.