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Optimal Taxation of Capital in the Presence of Declining Labor Share

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  • Orhan Erem Atesagaoglu
  • Hakki Yazici

Abstract

Numerous recent studies have documented that the labor's share in national income, which has been quite stable until the early 1980's, has been declining at a considerable rate since then. In this paper, we analyze the implications of this decline on the optimal capital and labor income taxation from the perspective of a government that needs to finance spending. Our main qualitative finding is that the optimal tax implications of the decline in the labor share depend on the mechanism responsible for it. In particular, if the labor share is declining because of rising market power or other mechanisms that raise the share of profits in national income, then this decline should optimally be accompanied with a rise in capital income taxes. If, on the other hand, the labor share is declining because of a rise in capital share, then it has no bearing on optimal capital income taxation. The quantitative significance of the decline in labor share for optimal capital taxes depends on the institutional details regarding the taxation of profits: in the baseline scenario, the optimal tax rate on capital income for the U.S. economy starts around zero in early 1980's and rises to about 25% by 2021 in response to the decline in labor share during the same period.

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  • Orhan Erem Atesagaoglu & Hakki Yazici, 2021. "Optimal Taxation of Capital in the Presence of Declining Labor Share," Bristol Economics Discussion Papers 21/739, School of Economics, University of Bristol, UK.
    • Handle: RePEc:bri:uobdis:21/739
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    2. Eeckhout, Jan & Fu, Chunyang & Li, Wenjian & Weng, Xi, 2021. "Optimal Taxation and Market Power," CEPR Discussion Papers 16011, C.E.P.R. Discussion Papers.
    3. Nakatani, Ryota, 2022. "Optimal fiscal policy in the automated economy," MPRA Paper 115003, University Library of Munich, Germany.
    4. Dami'an Vergara, 2022. "Minimum Wages and Optimal Redistribution," Papers 2202.00839, arXiv.org, revised Dec 2022.

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