Kokonas, Ν., "Capital Taxation in Life-Cycle Economies: Production Efficiency, Risk, and Bubbles"

Title: "Capital Taxation in Life-Cycle Economies: Production Efficiency, Risk, and Bubbles"

Speaker: Associate Professor Nikolaos Kokonas, University of Bath

Host:  Assistant Professor Ioannis Kospentaris, Department of Economics, Athens University of Economics and Business

Room:  76, Patission Str., Antoniadou Wing, 3rd floor, Room A36

Abstract: This paper studies optimal capital income taxation in an overlapping-generations economy with elastic labor supply, uninsurable idiosyncratic income risk, and government debt. We show that, contrary to standard results in the OLG literature, production efficiency generically holds when the government can issue debt and levy age-independent taxes on labor and capital income. A Robust Pareto Improvement argument `a la Aguiar et al. (2024) identifies the minimum set of fiscal instruments and the nature of shocks consistent with production efficiency. Analytical tax formulas decompose the optimal capital tax into two channels: a life-cycle channel, arising from endogenous, age-varying labor supply; and an insurance channel, stemming from market incompleteness. We identify conditions under which the insurance channel calls for capital income subsidies, whereas endogenous age variation in labor supply justifies a positive capital income tax when age-dependent taxation is unavailable. Finally, we establish an allocation equivalence between the baseline economy with debt and an alternative bubble economy, provided that bubble returns are taxed by the government. When bubble returns cannot be taxed, then the optimal capital income tax in the bubble economy is zero, even with life-cycle behaviour, age-independent taxes, and incomplete markets.