Capital taxation

the long version

This paper studies the efficiency gains from distorting savings in dynamic Mirrleesian private-information economies. We develop a method that pertubs the consumption process optimally, while preserving incentive compatibility. The Inverse Euler equation holds at the new optimized allocation. Starting from an equilibrium where agents can save freely allows us to compute the efficiency gains from savings disortions. We investigate how these gains depend on a limited set of features of the economy. We find an important role for general equilibrium effects. In particular, efficiency gains are greatly reduced when, rather than assuming a fixed interest rate, decreasing returns to capital are incorporated with a neoclassical technology. We compute the efficiency gains for the incomplete market model in Aiyagari [1994] and find them to be relatively modest for the baseline calibration. For higher levels of uncertainty, the efficiency gains can be sizable, but we find that most of the improvements can then attributed to the relaxation of borrowing constraints, rather than the introduction of savings distortions. Keywords: Capital taxation, inverse Euler equation, constrained efficient, Chamley-Judds. JEL Classifications: E6, H2.