Optimal time–consistent taxation with international mobility of capital

The United States relies for its government revenues more on the taxation of capital relative to the taxation of labor than countries in continental Europe do. In this paper we ask what can account for this. Our approach is to look at Markov perfect equilibria of a two– country growth model where both governments use labor, capital and corporate taxes to finance exogenously given streams of public expenditure under period–by–period balanced budget constraints. There is no commitment technology and the equilibrium policies are time–consistent. We find that differences in productivity, size, and government spending can account for the heavy American reliance on capital taxation. ∗Klein: Department of Economics, University of Western Ontario, London, Ontario, Canada N6A 5C2 and EPRI (e-mail: [email protected]); Quadrini: Department of Economics, Stern School of Business, New York University, New York, NY 10012, USA, CEPR and NBER (e-mail: [email protected]); Ŕıos-Rull: Department of Economics, 3718 Locust Walk, University of Pennsylvania, Philadelphia, PA 19104, USA, CAERP, CEPR and NBER (e-mail: [email protected]). We thank Per Krusell and Enrique Mendoza and the attendants of seminars at Duke University, Cemfi, CEPR conference on Optimal Taxation in Tilburg and the 2000 Hydra Macroeconomics Conference on the cost of business cycles as well as the referees of this paper. Rı́os-Rull thanks the National Science Foundation and the University of Pennsylvania Research Foundation.