Capital taxes and redistribution: The role of management time and tax deductible investment

Should capital income be taxed for redistributional purposes? Judd (1985) suggests that it should not. He finds that the optimal capital tax is zero at steady state from the point of view of any agent. This paper re-examines this question in an infinitely-lived worker-capitalist model, in which capitalists devote management time to build capital. Two forms of capital taxation are considered: one for which investment is not tax deductible (corporate tax) and a second one for which investment is fully and immediately tax deductible (dividend tax). Our main results are as follows. The optimal corporate tax is zero. In contrast, the optimal dividend tax is in general not zero at steady state and depends on preference parameters, life-time wealth and the point of view (Pareto weights) of the benevolent policymaker. For the case of a fiscal authority with utilitarian preferences, we find that labor tax rates should be cut down to 4 per cent while dividend tax rates should be increased to 42 per cent.