Taxing capital income: a bad idea

Under a narrow set of assumptions, Chamley (1986) established that the optimal tax rate on capital income is eventually zero. This study examines and extends that result by relaxing Chamley’s assumptions, one by one, to see if the result still holds. It does. This study unifies the work of other researchers, who have confirmed the result independently using different types of models and approaches. This study uses just one type of model (discrete time) and just one approach (primal). Chamley’s result holds when agents are heterogeneous rather than identical, the economy’s growth rate is endogenous rather than exogenous, the economy is open rather than closed, and agents live in overlapping generations rather than forever. (With this last assumption, the result holds under stricter conditions than with the others.)