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The marginal welfare cost of capital taxation: Discounting matters

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  • Santoro, Marika
  • Wei, Chao

Abstract

We interpret the marginal welfare cost of capital income taxes as the present discounted value of consumption distortions. Such an asset market interpretation emphasizes the importance of the interest rate used to value future distortions, especially in the presence of uncertainty. We find that the interest rate decreases as the tax rate increases, thus increasing the welfare cost. The variations in the interest rate are caused by amplified responses of consumption to exogenous shocks as a result of capital taxation. The welfare cost may be underestimated if variations in interest rates are ignored, especially when tax rates are high.

Suggested Citation

  • Santoro, Marika & Wei, Chao, 2013. "The marginal welfare cost of capital taxation: Discounting matters," Journal of Economic Dynamics and Control, Elsevier, vol. 37(4), pages 897-909.
    • Handle: RePEc:eee:dyncon:v:37:y:2013:i:4:p:897-909
    DOI: 10.1016/j.jedc.2012.12.006
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    References listed on IDEAS

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    More about this item

    Keywords

    Welfare cost; Capital income taxes; Asset market;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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