Taxing capital income as Pigouvian correction: the role of discounting future Macroeconomic Dynamics

In this work we find that the zero capital income tax result might not hold, even at the steady state, when the government discount rate differs from the individual one. As intuitive Pigouvian considerations would suggest, capital income should be taxed (subsidized) when the government is less (more) impatient than individuals are. However, a counterintuitive asymmetry emerges as for the steady state, since in the long run capital income cannot be taxed due to the explosive distortionary effect of positive taxes. The asymmetry is ruled out with a logarithmic utility function, since in this case the anticipated policy path does not affect current individual choices and, thus, the cumulative distortionary effect of taxes disappears.