Capital taxation, inequality and polarisation under lack of commitment

Research from models allowing for heterogeneity in asset endowments and endogenously chosen …scal policy suggests a positive link between income inequality and both capital taxes and polarisation. However, while the second prediction receives empirical support, capital tax rates are negatively related with inequality in the data for OECD democracies. Using the basic neoclassical model with capital asset inequality, we show that both stylised facts can be explained in a majority equilibrium with representative democracy and Markov perfect policy. This result is driven by the fact that the concentration of capital holdings and the capitalist bias associated with the political economy system work as substitutes in reducing the ine¢ ciencies associated with lack of commitment. Keywords: Markov-perfect policy; Representative democracy; Capital taxation JEL Classi…cation: E62, H21 We would like to thank Guido Ascari, Isabel Correia, Marcello D’Amato, Matthias Ho¤mann, Kevin Lansing, Paul Levine, seminar participants at the Bank of England, the Universities of Surrey and Zurich as well as participants at the ASSET and EU Commission REPLHA Conferences (2011) for helpful comments and suggestions. We are grateful for …nancial support from the ESRC, Grant No. RES-062-23-2292, but the views expressed here are entirely our own.